**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-K**

 
| **(Mark  One)** |
|-----------------|
| **ý**      | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
| ** **      | **For the  fiscal year ended June 30, 2005** |
| ** **      | **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 & COMPANYHOLDINGS**

(Exact name of registrant as specified in its charter)
| **Delaware**  (State or other jurisdiction of  incorporation or organization) |   | **52-2211537**  (I.R.S. Employer Identification No.) |
|-------------------------------------------------------------------------------|--------|------------------------------------------------------|

 

**901 N. Glebe RoadArlington, VA  22203**(Address of principal executive offices, including zip code)

 

**(703) 258-8000**(Registrant’s telephone number, including area code)

 

**Securitiesregistered pursuant to Section 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** |
| **(32,663,706 shares outstanding as of July 31,  2005)** | ** ** | ** **                  |

 

Indicate by check markwhether the registrant: (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the Registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.

 

Yes  ý          No  o

 

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

 

Yes  o          No  ý

 

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

 

Yes  ý          No  o

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes  o          No  ý

 

The aggregate marketvalue of the voting and non-voting common equity held by non-affiliates of theRegistrant was $832,164,144 as of June 30, 2005.

 

**Documents Incorporated by Reference**

 

Portions of theDefinitive Proxy Statement for the Annual Meeting of Stockholders to be held onor about November 11, 2005 are incorporated by reference into Part IIIof this Form 10-K.

 

 

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**PART I**

 

**Item1.  Business.**

 

**BusinessCombination**

 

Effective as of July 31,2005, Watson Wyatt & Company Holdings completed the acquisition ofassets and assumptions of liabilities of Watson Wyatt LLP (“WWLLP”) (“theacquisition”), a privately held limited liability partnership registered inEngland.  Prior to this date, WatsonWyatt & Company Holdings and WWLLP jointly offered services under theWatson Wyatt Worldwide brand through an alliance established in 1995.  In connection with this alliance, WatsonWyatt & Company Holdings held an interest in WWLLP.  Upon consummating the acquisition, WatsonWyatt & Company Holdings acquired the remaining interest in the assetsof WWLLP.  Additional information aboutthe acquisition is set forth in the Form 8-K (File No. 001-16159)filed with the SEC by Watson Wyatt & Company Holdings on August 1,2005.

 

Since the acquisitionoccurred subsequent to the end of fiscal year 2005, the Consolidated FinancialStatements and related information contained herein do not reflect the acquisition.  For more information regarding this business acquisitionand the accounting for the company’s share of WWLLP and Watson Wyatt Holdings(Europe) Limited (“WWHE”) prior to the business acquisition, see Note 2 andNote 4, respectively, of Notes to the Consolidated Financial Statementsincluded in Item 15 of this report.

 

**Business Overview**

 

Watson Wyatt &Company Holdings, including its subsidiaries (collectively referred to as “we”,“Watson Wyatt” or the “company”), is a global human capital consulting firm. Wehelp our clients enhance business performance by improving their ability toattract, retain and motivate qualified employees. We focus on deliveringvalue-added consulting services that help our clients anticipate, identify andcapitalize on emerging opportunities in human capital management.  As of June 30, 2005, we implemented thisstrategy through approximately 3,875 associates in 63 offices located in 20countries.  As a result of theacquisition, we now have approximately 6,000 associates in 32 countries.

 

As leading economiesworldwide have become more services-oriented, human capital has becomeincreasingly important to companies and other organizations. The heightenedcompetition for skilled employees, unprecedented changes in workforcedemographics, regulatory changes related to compensation and retiree benefits,and rising employee-related costs have increased the importance of effectivehuman capital management. We help our clients address these issues by combiningour expertise in human capital management with consulting and technology, toimprove the design and implementation of various human resources, or HR, programs,including compensation, retirement and health care plans.

 

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

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

•                  Health care,  disability and other group benefit plans

•                  Investment  consulting services to pension plans

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

•                  Actuarial  services

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

•                  Call center  strategy, design and tools

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

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

•                  Strategies to  align workforce performance with business objectives

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

•                  Strategies for  attracting, retaining and motivating employees

•                  Performance  management |

 

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

 

***CompetitiveAdvantage***

 

We believe that ourcompetitive advantages include our strong client relationships, our thoughtleadership and our experienced management team.

 

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

 

We also believe that weare at the forefront of many issues affecting human capital through ourresearch, surveys and participation in policy-making.  Our thought leaders are often called upon bythe media and government to express opinions on issues affecting health carebenefits, retirement plan design and executive compensation.

 

Our senior managementteam is strong, with an average tenure of 15 years with the company and areputation for transparency and accountability. We consider this group to be a major asset to the company.

 

***CorporateInformation***

 

Including predecessors,we have been in business since 1946.  TheWyatt Company was incorporated in Delaware on February 17, 1958.  We conducted business as The Wyatt Company from1958 until changing our corporate name to Watson Wyatt & Company inconnection with the establishment of the Watson Wyatt Worldwide alliance in1995.  Watson Wyatt & CompanyHoldings was incorporated in Delaware on January 7, 2000, and conductsbusiness through its principal operating subsidiary, Watson Wyatt & Company.

 

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***WatsonWyatt Worldwide Alliance***

Recognizing our clients’ need for consulting services worldwide, in the late1970s we established operations throughout Europe by acquiring local firms andopening new offices.  In 1995, inresponse to the rapidly increasing globalization of the world economy, we madea strategic decision to strengthen our European capabilities significantly andextended our global reach. We entered into an alliance with R. Watson &Sons (Watson Wyatt LLP, or WWLLP), a leading United Kingdom-based actuarial,benefits and human resources consulting partnership founded in 1878. Since1995, we have marketed our services globally under the Watson Wyatt Worldwidebrand, sharing resources, technologies, processes and business referrals withWatson Wyatt LLP.

As of June 30, 2005, the Watson Wyatt Worldwide alliance maintains 90 officesin 32 countries and employs approximately 6,000 associates. Watson Wyatt &Company Holdings at that date was responsible for operations in 20 countries inNorth America, Latin America and Asia-Pacific while Watson Wyatt LLP wasprimarily responsible for operations in the United Kingdom and Ireland.  The alliance was responsible for operationsin continental Europe, principally through a jointly-owned holding company,Watson Wyatt Holdings (Europe) Limited.  Beforethe acquisition, Watson Wyatt & Company owned 25 percent of theholding company; Watson Wyatt LLP owned 75 percent.

 

In connection with thecompany’s acquisition of WWLLP, the alliance was terminated effective July 31,2005.  Since the acquisition occurredsubsequent to the end of fiscal year 2005, the Consolidated FinancialStatements and related information contained herein do not reflect the acquisition.  For more information regarding this business acquisitionand the accounting for the company’s share of WWLLP and WWHE prior to thebusiness acquisition, see Note 2 and Note 4, respectively, of Notes to theConsolidated Financial Statements included in Item 15 of this report.

 

**HumanResources Consulting Industry**

The growing demand for employee benefits and human capital consulting servicesis directly related to the increasing size and complexity of today’s humanresources programs and the societal forces that are stimulating their rapidchange.  In the United States alone,employers spend more than $6.7 trillion annually in direct costs of humancapital programs, such as compensation and benefits.  In 2003, U.S. employers contributed nearly $200billion to pension and profit-sharing plans, and more than $480 billion togroup health insurance programs, while the assets of U.S. employer-sponsoredretirement plans approximated $9.8 trillion.

Employers, regardless of geography or industry, are facing challenges involvingthe management of their people. Changing technology, shifting economic conditions,critical skill shortages and an aging population in many developed countrieshave increased competition for talented employees.  At the same time, employees’ expectationsrelating to compensation, benefits and other HR services are growing.  To remain competitive, employers must addressthese challenges effectively.

 

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**ConsultingServices**

Our North American operations include three principal practice groups:Benefits, Technology Solutions and Human Capital.  Outside North America, our operations areorganized and managed on a geographic basis. The percentage of revenues generated in the various groups is as follows:

 
| ** **                                        | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Benefits Group                                    |       | 63       | %          | 64       | %          | 61       | %          |
| Technology Solutions Group                        |       | 10       |       | 11       |       | 14       |       |
| Human Capital Group                               |       | 8        |       | 7        |       | 7        |       |
| International                                     |       | 13       |       | 12       |       | 11       |       |
| Other (including Communication and Data Services) |       | 6        |       | 6        |       | 7        |       |
| Total                                             |       | 100      | %          | 100      | %          | 100      | %          |

 

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

***Benefits Group***

Our Benefits Group – with 1,600 associates – consists primarily of consultingpractices in retirement, group and health care, and pension investmentmanagement.  It is our largest and mostestablished practice, with a franchise dating to 1946.  This group works with clients to createcost-effective retirement and health care benefits programs that help attract,retain and motivate a talented workforce. We strive to provide tailored benefits programs for our clients, and webase our recommendations on extensive research. Our Benefits Group accounted for approximately 63 percent of our totalsegment revenues for the fiscal year ended June 30, 2005.

 

*RetirementConsulting*

We are one of the world’s largest advisers on retirement plans, providingactuarial and consulting services for large defined benefit and definedcontribution retirement plans. Our consultants work with clients to assess theimpact that changing workforce demographics will have on their retirementplans, corporate cash flow requirements and retiree benefits adequacy andsecurity.

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

 

Our target market forretirement consulting is companies with large defined benefit plans, such asthe Fortune 1000, Pensions & Investments 1000 (P&I 1000), andother similarly-sized plans and plan sponsors. Watson Wyatt is one of theleading service providers to our target market of the combined list of theP&I and Fortune 1000.  Ourconsultants provide actuarial services and are the named actuaries to many ofthe world’s largest retirement plans, including the three largest corporatepension plan sponsors in the United States. Additionally, our corporate client retention rate within this group hasremained very

 

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high, averaging over 95percent over the past two years. The market for actuarial consulting for theselarge companies is fragmented, and no single consulting firm dominates thistarget market.

 

Our retirement servicesinclude:

 

•                  Strategic plan design

•                  Actuarial services

•                  Administrative services

•                  Analysis and recommendations onfunding and expense strategy

•                  Defined contribution servicesincluding discrimination testing and vendor selection

•                  Multinational asset poolingconsulting

•                  Financial reporting

•                  Valuation and diagnostic software andsystems

•                  Assistance with changes relating tomergers, acquisitions and divestitures

•                  Compliance consulting

 

Inboth the defined benefit and defined contribution areas, we emphasizeresearch-based consulting to design retirement programs that align our clients’workforces with their business strategies. Some examples of our innovativeplans and programs are:

 

•                  Stable Value - an alternativeretirement plan design that combines the benefit features of definedcontribution and cash balance plans with the rules of a traditionaldefined benefit plan to facilitate plan redesigns in today’s uncertainenvironment.  Combined with assetstrategies, the Stable Value Plan can help companies address the financialvolatility they face due to their pension plan

 

•                  Flex Pension PlusTM – forCanadian organizations, a tax-effective, supplemental retirement plan forattracting and retaining key employees

 

•                  Phased Retirement Programs – acombination of programs that help clients attract and retain older workers byenabling them to balance work/life needs through a gradual transition toretirement

 

To enhance our retirementconsulting services, we dedicate significant resources to technology systemsand tools to ensure the consistency and efficiency of service delivery in allour offices worldwide. We also maintain extensive proprietary databases, WatsonWyatt COMPARISONTM and BenTrackTM, that enable ourclients to track and benchmark benefit plan provisions in the United States andthroughout the world. Some of our tools and technology solutions include:

 

•                  PensionPath®  – in partnership with our Technology SolutionsGroup, we deliver this full-featured, web-based solution designed to meet thepension administration needs of companies of all sizes

 

•                  Retirement Management Online – aportal that links clients to a suite of Watson Wyatt tools, research and data

 

•                  FASTool – an interactive tool thatallows the immediate comparison of balance sheet information and assumptionsrelated to pension and retiree medical plans for large publicly-tradedcompanies

 

•                  Quick Peek® Online – aweb-enabled tool that allows pension plan sponsors to quickly and easily modela variety of financial and business situations, and project retirement plancontributions, funded status and expense

 

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*Group andHealth Care Consulting*

Employers look to provide health and welfare benefits that will help them toattract and retain qualified workers and to enhance the health and productivityof their workforce.  Given increasinghealth care costs, declining employee satisfaction and the increasedadministrative burden for U.S. companies, this challenge has never beengreater.  Globally, many health caresystems are strained by shrinking resources and increasing demand due topopulation aging and declining health status. In the United States, these underlying forces are creating pressure fornew approaches to providing health care benefits for workers and retirees –approaches that engage patients as consumers of health care and not justpassive recipients.  These methods encourageemployees to participate more actively in the health care buying decision byputting workers in charge of spending their own health care dollars and byproviding them with the tools and information necessary to make wiser healthpurchasing decisions.

 

Clients ask us to helpthem with the design, financing, administration, communication and managementof their health and welfare benefit plans, to improve employee health andproductivity, and to control their health-related benefit costs.

 

Our services include:

 

•            Strategic plan design of health andwelfare, paid time off and flexible benefit plans, including designs thatfeature consumerism and health savings accounts

•            Retiree health programs

•            Health and productivity management

•            eHealth strategy and implementation

•            Total program management

•            Vendor performance and management

•            Measurement of program effectiveness

•            Assistance with plan changes relating tomergers, acquisitions and divestitures

 

Our approach to groupbenefits consulting is data-driven, research-based and makes use ofsophisticated consulting tools, including:

 

•                  BenefitConnectTM – acustomizable, web-based application that combines self-service employee toolswith administrative and call center components to facilitate the administrationand management of health and welfare benefits

 

•                  I-E Engine – an innovative technologythat automates the vendor selection and management process through five modulesthat support specific components of the health and welfare benefits life cycle

 

•                  PreViewTM – a medicalbenefits cost modeling system that accurately and quickly models medical claimsunder alternative plan designs, covered populations and managed care deliverysystems

 

•                  ConsumerHealthView – a cost modelingsystem that assesses the short-term and long-term financial impact ofconsumer-driven health plans

 

•                  Health Plan Value LibraryTM– a database of information on the cost, quality and accessibility of healthplans, used to screen and evaluate health plans

 

 

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•                  Avoidable Claims Analysis – a dataanalysis system that identifies opportunities for the reduction of medicalclaims through health management programs

 

*InvestmentConsulting*

Pension plan sponsors face challenges in today’s market environment.  Through our registered investment advisorsubsidiary, we offer investment consulting services that help clientsthroughout the world maximize the risk-adjusted return on their retirement planassets, develop governance policies and strategies, and design investmentstructures to manage financial liabilities within the context of their overall organizationalobjectives.

 

Our services include:

 

•                  Asset/liability modeling and assetallocation studies

•                  Governance and investment policydevelopment

•                  Investment policy implementation

•                  Investment structure analysis

•                  Investment manager selection andevaluation

•                  Performance evaluation and monitoring

 

We offer the followingintegrated services for plan sponsors:

 

•                  Watson Wyatt Pension Risk ManagementTM– an integrated methodology for determining the appropriate amount ofinvestment risk for a plan and allocating that risk across investment decisions

 

•                  Watson Wyatt Advanced InvestmentSolutions® – fiduciary outsourcing for defined benefit plans.  We work with the plan sponsor to develop aninvestment policy and directly manage the implementation of that policy

 

***TechnologySolutions Group***

 

Our Technology Solutions Group of 335 associatesprovide technology, consulting and outsourcing services to a marketincreasingly defined by four key dynamics: enterprise resource planning systems(ERPs), total benefits outsourcing (TBO), human resource outsourcing (HR BPO)and co-sourcing.

 

ERP vendors are expanding into broader HR services, includingbenefits or compensation administration, looking for increased revenues throughupgrades and additional services offerings. TBO and HR BPO providers are also expanding their service lines acrossadditional HR domains and promoting a “one-stop-shop” method to benefitsadministration. Watson Wyatt’s technology business strategy is targeted towardsbusinesses that use a mix of sourcing strategies.  Our approach allows an organization to chooseto outsource (1) the technology only, (2) the technology andadministration services, or (3) the technology, administration andemployee support services.  Combiningbest-in-class technology solutions with outsourcing services offers employerslower cost, greater flexibility and more comprehensive options than stand-aloneERPs or total outsourcing approaches.

 

Watson Wyatt has long provided benefitsadministration solutions to our clients.  We offer targeted applications in our coreareas, including:

 

•                  PensionPath® – thisweb-based solution is designed to meet the pension administration needs ofcompanies. The offering includes case management and administration tools tomanage the entire life

 

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cycleof pension administration, from new hire to retirement, and employeeself-service tools that enhance workers’ understanding of their retirementbenefits’ future value.

 

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

 

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

 

BenefitConnectserves the entire spectrum of potential users, including employees, planadministrators, customer service representatives, HR and benefit managers,vendors and carriers. It can be configured and branded to meet companies’unique requirements and plan and vendor formats.

 

BenefitConnect’sfull functionality helps users manage benefits data, make eligibilitycalculations, facilitate annual and ongoing plan enrollment, integrate withpayroll solutions and carriers to process participant elections, and manage andtrack employee calls, transactions and cases. It also allows companies tocreate or leverage their internal call center with a powerful suite ofweb-based call center tools.

 

•                  Reward*®*–**a suite of compensation managementapplications that automates all aspects of pay delivery – including marketpricing, compensation design and analysis and manager self-service – forcompensation planning

 

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

 

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

 

Wealso provide clients with strategic, research-based HR technology and servicedelivery consulting, while working with them to align their HR strategy withtheir business goals and to use HR technology to improve customer satisfactionand sustainable return on investment (ROI). Our services in this area includevendor assessments and selection and service delivery model development,including shared services strategy and design.

 

Our approach establishesthe foundation for employee relationship management, allowing our clients toconnect their people and processes to their business strategy to improveperformance.  Our Technology SolutionsGroup represented approximately 10 percent of our total segment revenues forthe fiscal year ended June 30, 2005.

 

***HumanCapital Group***

Our Human Capital Group of 170 associates helps clients achieve competitiveadvantage by aligning their workforce with their business strategy. Thisincludes helping clients develop and implement strategies for attracting,retaining and motivating their employees to maximize the return on theirinvestment in human capital. Our Human Capital Group represented approximately 8percent of our total segment revenues for the fiscal year ended June 30,2005.

 

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Our Human Capital Groupfocuses in three principal areas: executive compensation, Strategic Rewards*®* and organization effectiveness.

 

*ExecutiveCompensation*

We advise our clients’ management and boards of directors on executive payprograms, including cash compensation, stock options and stock purchase plans,and on ways to align pay-for-performance plans throughout the organization toincrease stockholder value.

*Strategic Rewards®*

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

 

*OrganizationEffectiveness*

We help clients clarify and implement business strategy, recognizing the impactof employee attitudes, commitment and effective team and leadership developmenton business success. We provide a wide array of services centered onorganization assessment, including organization measurement and surveys. In thearea of talent management, we provide tools and methodologies for talentselection and development, succession planning and performance management. Wealso provide consulting regarding organization design and the organization anddevelopment of the HR function.

We have created the *Watson Wyatt Human CapitalIndex*â, aproprietary tool for demonstrating the relationship between the effectivenessof an organization’s human capital practices and the creation of superior stockholderreturns.

 

Our WorkUSA®/WorkCanadaTMdatabase includes the opinions of 12,000 North American employees surveyedindependently, reflecting a large cross-section of jobs and industrytypes. Our clients compare their own employee survey results against thesenorms to identify workplace perceptions and satisfaction and commitment levels.

***International Operations***

Our international segment is comprised of operations in 26 offices inAsia-Pacific and Latin America, employing 940 associates, which generallyprovide our full array of services. This segment represented approximately 13percent of our total segment revenues for the fiscal year ended June 30,2005.

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

 

We also providecompensation and benefits surveys in the region, with more than 50 differentsurvey products, as of fiscal year end. We are a leading provider of retirementand other employee benefit consulting services in Asia-Pacific, and we provideinvestment consulting services to some of the largest pension plans in Japanand Hong Kong.  We were named HR ConsultingFirm of the Year in Hong Kong by *China Staff*magazine for the past seven years in a row.  In addition to our human capital and benefitsconsulting services, we also market technology solutions to clients in theregion.

 

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Our Latin Americanpresence began in the early 1980s in Mexico and grew to include such majormarkets as Brazil in the 1990s.  We havemost recently opened new offices in Chile and Uruguay.  With deregulation, privatization and theinflux of multinational corporations, we believe there are significantopportunities for growth in the region, both in the benefits area – where mostof our services are concentrated currently – and in the human capitalconsulting area.

 

***OtherServices***

*Communication Consulting*

In our communication consulting group, we help clients connect people with theorganization’s purpose, driving both results and behavioral change.  Our award-winning work and ground-breakingresearch prove that effective communication increases total returns toshareholders; improves service, quality and productivity levels; helps fuelgrowth; enhances organizational ability to manage change successfully; buildsemployee community, trust and commitment; and educates, engages and motivatesemployee behavioral change.  Working with clients who have responsibilityfor employee communication in human resources, corporate or line functions, ourconsultants combine strong creative skills with technical excellence to createprograms that range from high-level strategic planning to tacticalimplementation.

 

We help clients developand implement communication strategies for diverse issues, including:

 

•                  Clarifyingthe financial value and scope of employee compensation and benefits andenhancing employees’ appreciation of their total rewards package

 

•                  Drawinga clear line of sight between employee performance and company objectives throughopen communication and leadership communication training

 

•                  Optimizingthe use of technology in communication through audits and best practice design

 

•                  Facilitatingorganizational change so that all stakeholders fully understand the change andtheir role in its success

 

•                  Maintainingemployee trust, confidence and commitment through all cycles of performance

 

•                  Demonstratingthe return on investment (ROI) of employee communication in achieving businessobjectives

 

•                  Targeting,attracting and hiring the right talent to meet business objectives throughinnovative communication materials

 

*WatsonWyatt Data Services*

Watson Wyatt Data Services provides a comprehensive array of globalcompensation, benefits and employment practices information that is oftenstudied and cited by many of our clients and competitors. In the United States,we publish and market an extensive library of reports on human resourcesissues, and more than 2,600 organizations participate in one or more of ourannual surveys. Our databases contain compensation information for U.S. companiesthat employ over 16 million workers. Detailed compensation and benefits data is maintained for 3 millionworkers in virtually every industry sector and major metropolitan area.  Outside of the United States, at June 30,2005, our worldwide alliance offered more than 80 remuneration, benefits andemployment practice reference guides, covering 50 countries and 5 continents.In addition to our annual survey reports, we also offer many reference worksintended to help practitioners create or maintain programs in a variety ofsubject areas, including variable pay, performance management and personnelpolicies.

 

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***IntegratedService Approach***

While we focus our consulting services in the principal areas described above,we draw upon consultants from our different practices to deliver integratedservices to meet the needs of our clients. An example is our Total Rewardsapproach, which encompasses compensation, benefits, career growth and companyculture. We help clients determine the correct mix of reward programs toattract and retain the right employees and to motivate them to produce desiredresults.  We also assemble cross-practiceteams to help clients through mergers and acquisitions.

 

***Salesand Marketing***

Our growth strategy is based on a commitment to ensuring client satisfactionthrough our account management program. Our approximately 50 account managers focus on effectively deliveringservices to clients and on expanding our relationships across service lines,geographic boundaries and divisions within client companies.  A key element of this program is an approachwe call ClientFirstTM. Using proprietary processes and tools, wework with clients to define their needs and expectations before an engagementbegins and then continually measure our performance according to agreed-uponstandards.

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

 

**Clients**

We work with major corporations, emerging growth companies, government agenciesand not-for-profit institutions in North America, Latin America andAsia-Pacific across a wide variety of industries.  Our client base is broad and geographicallydiverse.  For the fiscal year ended June 30,2005, our 10 largest clients accounted for approximately 11 percent of ourconsolidated revenues, and no individual client represented more than 2 percentof our consolidated revenues.

**Competition**

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

 

Our current andanticipated competitors include:

 

•            Major human resources-focused consultingfirms that compete in serving the large employer market worldwide, such asMercer Human Resource Consulting, Towers Perrin and Hewitt Associates

 

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

 

•            The human resources consulting divisions ofdiversified professional services, financial services and insurance firms, suchas PricewaterhouseCoopers, Deloitte & Touche, Ernst & Young andAon.

 

•            Information technology consulting firms,such as Accenture, IBM, ACS and BearingPoint, as well as Internet/intranetdevelopment firms

 

•            Boutique consulting firms comprisedprimarily of professionals formerly associated with the firms mentioned above

 

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The market for ourservices is subject to change as a result of increased regulatory, legislative,competitive and technological developments and competition from established andnew competitors. We believe the primary factors in selecting a human resourcesconsulting firm include reputation, the ability to provide measurable increasesto stockholder value, global scale, service quality and the ability to tailorservices to a clients’ unique needs. We believe we compete favorably withrespect to these factors.

 

**Employees**

**As of June 30, 2005, the company employed 3,875 associatesas follows:

 
| Benefits Group                                    |   | 1,600 |   |
|---------------------------------------------------|--------|-------|--------|
| Technology Solutions Group                        |   | 335   |   |
| Human Capital Group                               |   | 170   |   |
| International                                     |   | 940   |   |
| Other (including Data Services and Communication) |   | 600   |   |
| Corporate                                         |   | 230   |   |
| Total                                             |   | 3,875 |   |

 

None of our associatesare subject to collective bargaining agreements.  We believe relations between management andassociates are good.

**Risk Factors**

 

In addition to thefactors discussed elsewhere in this report, the following are some of theimportant factors that could cause our actual results to differ materially fromthose projected in any forward-looking statements.

 

***Watson Wyatt’s success will continue to depend on its ability torecruit and retain qualified consultants generally as well as Watson Wyatt LLPkey personnel; our failure to do so could adversely affect our ability tointegrate Watson Wyatt LLP and generally to compete successfully******.***

 

WatsonWyatt’s success depends on its ability to attract, retain and motivatequalified personnel generally, including executive officers, key managementpersonnel and consultants. After the acquisition, the performance of the globalbusiness will continue to be subject to Watson Wyatt’s ability to retainqualified personnel. We cannot assure that we will be able to attract andretain qualified consultants, management and other personnel necessary for thedelivery of our sophisticated and technical services to clients.

 

Withrespect to the business acquired from WWLLP in particular, Watson Wyatt’songoing success also will be subject to Watson Wyatt’s ability to retain WatsonWyatt LLP key personnel. We cannot assure that Watson Wyatt LLP key personnelwill remain employees of Watson Wyatt after the acquisition. If Watson WyattLLP key personnel choose not to stay with Watson Wyatt after the acquisition,we may experience substantial disruption in our efforts to integrate theEuropean business, which could adversely affect our performance. In addition,if any key personnel were to join an existing competitor or form a competingcompany, some clients could choose to use the services of that competitorinstead of our services.

 

***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 business generation capabilities and project execution skills of our consultants. In particular, our consultants’ personal relationships with our clients are a critical element of

 

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obtaining and maintaining client engagements. Losing consultants and account managers who manage substantial client relationships or possess substantial experience or expertise could adversely affect our ability to secure and complete engagements, which would adversely affect our results of operations.

 

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.

 

***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 may have to lower our prices, which would have an adverse effect on our revenues and profit margin.

 

***Demand for our services may decrease for various reasons, including a general economic downturn or a decline in a client’s or an industry’s financial condition, 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, 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 would be adversely affected.

 

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***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, 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:

 

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

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

•                  A claim that employee benefit plan documents were misinterpreted or plan amendments were misstated in plan documents, leading to overpayments to beneficiaries.

 

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. For a discussion of significant legal proceedings, please refer to “Legal Proceedings” on page 19. 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.

 

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

 

Insurancemarkets have hardened over recent years for most classes of professionalliability risk. As the number of claims has increased against professionals andagainst actuaries in particular, the cost of malpractice insurance has beenincreasing substantially, and the deductible or self-insured retention has beenincreasing. Availability and price of insurance are subject to many variables,including general market conditions, loss experience in related industries andin the actuarial and benefits consulting industry, and the specific claimsexperience of an individual firm. As a result of the acquisition of WatsonWyatt LLP, the Company will be providing services in a larger geographic marketand therefore may be exposed to a greater number of claims arising from itsexpanded operations. In the future there can be no assurance that Watson Wyattwill continue to be able to obtain insurance on comparable terms to what it hasobtained in the past. Increases in the cost of insurance could affect theprofitability of Watson Wyatt and the unavailability of insurance to covercertain levels of risk could have an adverse effect on our financial condition,particularly in a specific period.

 

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

 

WatsonWyatt intends to continue and grow the business of providing consultingservices to insurance and financial services companies. The risk of malpracticeclaims from this line of business may be greater than from some of our currentlines of business and claims may be for significant amounts.

 

***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 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;

 

•                  The level of vacation and holidays taken by our associates; 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 $10.8 million to $14.3 million.

 

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***If we do not successfully integrateWWLLP, we may not realize the expected benefits of the acquisition.***

 

Weexpect that the acquisition will result in business opportunities and newprospects for growth through new and expanded client relationships and anintegrated capital structure that facilitates business development on a globalscale. The company may never realize these expected business opportunities andgrowth prospects. Integrating the operations of WWLLP and Watson Wyatt involvesthe integration of businesses that, while participating in a business alliance,have previously operated independently and under different governance andorganizational structures. The difficulties of integrating the operations ofthese businesses include:

 

•            Thechallenge of effecting integration while carrying on ongoing business;

 

•            Demonstratingto existing and potential clients that the acquisition will not adverselyaffect customer service standards or business focus;

 

•            Thenecessity of coordinating what were previously geographically separateorganizations;

 

•            Thepotential incompatibility of the business cultures of the two companies; and

 

•            Thepossibility that key managers, consultants and other personnel may not besatisfied or happy at Watson Wyatt after the acquisition and may elect toleave.

 

***Integrating WWLLP may interruptother activities of Watson Wyatt.***

 

Theprocess of integrating operations could cause an interruption of or loss ofmomentum in the activities of one or more of Watson Wyatt’s businesses afterthe acquisition. Members of Watson Wyatt’s senior management may be required todevote considerable amounts of time after the acquisition to this integrationprocess, which will decrease the time they will have to manage the company’sbusiness, service existing clients, attract new clients and attract and retainhighly skilled and motivated consultants.

 

WatsonWyatt after the acquisition has significantly more assets and employees than itdid before the acquisition. The integration process will require Watson Wyattto significantly expand the scope of its operational and financial systems,which will increase its operating complexity. Implementing uniform controls,systems and procedures may be costly and time-consuming, and there can be noassurance that our efforts to implement such controls, systems and procedureswill be successful. Management’s failure to effectively manage the companyafter the acquisition could have a material adverse impact on our business,financial condition and operating results as well as our ability to meetreporting requirements to the SEC and under Section 404 of theSarbanes-Oxley Act of 2002.

 

***As aresult of the acquisition of Watson Wyatt LLP, we will be subject to increasedrisks of doing business internationally after the acquisition.***

 

An increased portion ofWatson Wyatt’s business is located outside of the United States following theacquisition of WWLLP. As a result, a significantly larger portion of ourbusiness operations are subject to foreign financial and business risks, whichcould arise in the event of:

 

•                  currency exchange rate fluctuations;

 

•                  unexpected increases in taxes;

 

•                  new regulatory requirements and/orchanges in policies and local laws that materially affect the demand for ourservices or directly affect our foreign operations;

 

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•                  local economic and politicalconditions, including unusual severe or protracted recessions in foreigneconomies;

 

•                  unusual and unexpected monetaryexchange controls; or

 

•                  civil disturbance or othercatastrophic events that reduce business activity in other parts of the world.

 

These factors may lead todecreased sales or profits and therefore may have a material adverse effect onour business, financial condition and operating results after the acquisition.

 

***Accelerationof the shift by employers from defined benefit plans to defined contributionplans would adversely affect our business and our operating results.***

 

Watson Wyatt currentlyprovides clients with actuarial and consulting services relating to bothdefined benefit and defined contribution plans. Defined benefit plans generallyrequire more actuarial services than defined contribution plans because definedbenefit plans typically involve large asset pools, complex calculations to determineemployer costs, funding requirements and sophisticated analysis to matchliabilities and assets over long periods of time. The trend is toward increaseduse of defined contribution plans, and Watson Wyatt has adjusted its businessplanning accordingly. If organizations shift to defined contribution plans morerapidly than we anticipate, the performance and results of operation of ourbusiness and our overall operating results could be adversely affected.

 

***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. The acquisition of Watson Wyatt LLP has increased the size of global operations to be integrated and may require additional resources to complete. 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 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.

 

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

 

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

 

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

 

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

 

***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

 

**Other**

 

Our annual reports on Form 10-K,quarterly reports on Form 10-Q, current reports on Form 8-K andamendments to those reports are available, without charge, on our web site(www.watsonwyatt.com) 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, theprinciple executive officer, other officers and members of management.  The company also has a Code of BusinessConduct and Ethics that applies to all of the Company’s directors.  Both codes are posted on our website.  Watson Wyatt’s Audit Committee, CompensationCommittee and Nominating and Governance Committee all operate pursuant towritten 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 documents are

 

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also available, withoutcharge, from our Investor Relations department, located in our corporateheadquarters at 901 N. Glebe Road, Arlington, VA 22203.

 

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

 

As of June 30, 2005,we operated in 63 offices in principal markets throughout the world.  Operations are carried out in leased officesunder operating leases that normally do not exceed 10 years in length. We donot anticipate difficulty in meeting our space needs at lease expiration.

 

The fixed assets owned byWatson Wyatt represented approximately 15 percent of total assets at June 30,2005, and consisted primarily of computer equipment and software, officefurniture and leasehold improvements.

 

**Item 3.****           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 matters reported on below involve themost significant pending or potential claims against us.

 

We reserve for contingentliabilities based on Statement of Financial Accounting Standards No. 5, “Accountingfor Contingencies” (SFAS 5) when it is determined that a liability, inclusiveof defense costs, is probable and reasonably estimable.

 

*GovernmentInvestigations:*

 

*SECExamination of Investment Advisers.*  In December 2003,the Securities and Exchange Commission (SEC) formally asked many of the majorinvestment consulting firms, Watson Wyatt Investment Consulting (WWIC) amongthem, to provide detailed information on their business structures andpractices in order to determine if conflicts of interest with money managersexist.  In March 2004, WWIC completed its responses to the SEC staff’srequests for information.  In May 2005,WWIC provided additional information to SEC staff in response to comments madein connection with its inquiry and amended its Form ADV to clarify thescope of its Advanced Investment Solutions service. This inquiry concluded withno adverse action being taken.

 

*Departmentof Justice Antitrust Investigation.*  In March 2004,the United States Department of Justice (DOJ) issued a Civil InvestigativeDemand (CID) to Watson Wyatt and other companies in the employee benefitsindustry.  On January 20, 2005, we received a supplementaryCID.  The DOJ sought to determine whether firms that have entered intoagreements with their clients limiting liability have done so in violation ofU.S. antitrust laws. Watson Wyatt provided information to DOJ in response tothe CIDs.   On June 24, 2005, DOJentered into a Consent Decree with Professional Consultants Insurance Company, Inc.(PCIC), a captive malpractice insurance carrier that provides some of ourmalpractice coverage.  PCIC settledwithout admitting to any violation of antitrust laws.  No action has been brought against WatsonWyatt or any of the PCIC members, and we continue to be a stockholder of and toobtain insurance from PCIC. The Consent Decree requires ratification by thecourt.

 

*New YorkState Attorney General.*  On December 17, 2004, theNew York State Attorney General issued a subpoena to Watson Wyatt seekinginformation about “override” and other insurance placementcompensation.   Preliminary data indicate that such paymentsaccounted for less than 0.2 percent of Watson Wyatt’s revenue over the pastfour years.  Watson Wyatt has provided information to the New York StateAttorney General’s in response to the subpoena in January 2005.  We have received no further inquiries from theNew York State Attorney General since responding.

 

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*ProfessionalLiability Claims:*

 

*IronWorkers Local 25 et al. v. Watson Wyatt & Co.* On July 8, 2004, Watson Wyatt was served with an amended complaint filedby a former client in the United States District Court for the Eastern Districtof Michigan.  The complaint alleged malpractice, breach of contract, andrelated claims in the performance of actuarial consulting.  The complaintstated that the plaintiff’s pension fund is underfunded as a result of thealleged deficiencies in our work.  In response to a discovery request, in January 2005the plaintiffs disclosed that their minimum damage claim is $53.7million.  We have established a loss and loss expense reserve in theamount of our professional liability insurance self-retention for this case.

 

*SBCHoldings, Inc.*  On July 23, 2004, we receiveda demand letter from counsel for a client alleging that errors in valuationsfor 2001 and subsequent years understated the liabilities of its pension planand overstated its net worth.  As a result, the client claimed it did notannuitize its defined benefit plan and redeemed its stock at an inflatedprice.  On April 15, 2005 we filed a declaratory action in the U.S.District Court for the Eastern District of Michigan to compel arbitration ofthe matter.  On May 5, 2005, SBC filed an answer and counterclaim tothe declaratory judgment action, alleging damages in excess of $46million.  We have established a loss and loss expense reserve in theamount of our professional liability insurance self-retention for this case.

 

*ClientDemand Letter.*  On February 8, 2005, we received ademand letter from counsel for a client alleging failure to ensure that themethod for performing certain benefit calculations under the pensionadministration system developed by Watson Wyatt for the client was consistentwith the method required under the client’s pension equity plan and the summaryplan description, and failure to advise the client of the discrepancies betweenthe plan documents and the pension system.  The demand letter claimeddamages in excess of $13 million and also sought to hold the client’s outside EmployeeRetirement Income Security Act (ERISA) counsel responsible for thedamages.  On March 3, 2005, we entered into an agreement with theclient and the client’s ERISA counsel in order to pursue resolution of thismatter through mediation.  We have established a loss and loss expense reservein a non-material amount for this case.

 

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

****At a special meetingof the stockholders of the company, held on July 22, 2005, the following proposalswere submitted to a vote of stockholders: (I) to approve the issuance of Watson Wyatt & Company Holdings Class Acommon stock in connection with the acquisition of assets and assumption ofliabilities from Watson Wyatt LLP; and (II) to elect one Class IIImember of the Board of Directors.

 

23,383,475shares were present and eligible to vote (32,601,190 shares were outstanding asof the Record Date), and the results of the meeting were as follows withrespect to each matter submitted to a vote of stockholders.

 

Proposal I.                                       To approve theissuance of Watson Wyatt & Company Holdings Class A common stockin connection with the acquisition of assets and assumption of liabilities fromWatson Wyatt LLP as contemplated by the business transfer agreement, dated asof April 15, 2005, among Watson Wyatt & Company Holdings, WatsonWyatt (UK) Acquisitions 2 Limited, The Wyatt Company Holdings Limited, bothwholly owned subsidiaries of Watson Wyatt & Company Holdings, andWatson Wyatt LLP:

 

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Ofthe proxies received, the votes were as follows:

 
| **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** | **Broker  Non-Votes** | ** ** |
|------------|------------|-------------|------------|-------------|------------|-----------------------|------------|
| 22,903,623 |       | 442,134     |       | 37,718      |       | 0                     | *          |

 

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*There were no broker non-votes, since all the proposals were considered“non-routine,” as per the New York Stock Exchange.

 

ProposalII.                                   To elect Chandrasekhar Ramamurthy to Class III Director of the board ofdirectors of Watson Wyatt & Company Holdings to serve for a termexpiring at the 2006 Annual Meeting of Stockholders, or until the election andqualification of his successor. The election of Mr. Ramamurthy wascontingent upon consummation of the acquisition.

 

Pursuantto the company’s Amended and Restated Certificate of Incorporation, thedirectorships are divided into three classes, Class I, Class II and Class III.The directorships in Class I expire as of the annual stockholders’ meetingin 2007 and will expire every three years thereafter; the directorships in Class IIwill expire as of the annual stockholders’ meeting in 2005 and every threeyears thereafter; and the directorships in Class III will expire as of theannual stockholders’ meeting in 2006 and every three years thereafter. As theterm of each of the classes of directors expires, directors of the company willbe elected to serve for a three-year period and until their respectivesuccessors have been duly elected and qualified.

 

Ofthe proxies received, the votes were as follows:

 
| **Nominee for Class III  Director**                       | ** ** | **For**    | ** ** | **Withheld** | ** ** |
|----------------------------------------------------------------|------------|------------|------------|--------------|------------|
| *Term expiring at the annual  meeting of stockholders in 2006* |       |       |       |         |       |
| Chandrasekhar Ramamurthy                                       |       | 22,285,870 |       | 1,072,470    |       |

 

The directors serving in Class I, Class IIand Class III and their remaining terms are as follows:

 

**Class I Directors**

*Term expiring at the annual meeting of stockholdersin 2007*

R. Michael McCullough

Paul N. Thornton

 

**Class II Directors**

*Term expiring at the annual meeting of stockholdersin 2005*

JohnJ. Gabarro

JohnJ. Haley

LindaD. Rabbitt

GeneH. Wickes

JohnC. Wright

 

**Class III Directors**

*Term expiring at the annual meeting of stockholdersin 2006*

GilbertT. Ray

JohnB. Shoven

ChandrasekharRamamurthy

 

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**Part II**

 

**Item 5.****           Market for Registrant’sCommon Equity, Related Stockholder Matters and Issuer Purchases of EquitySecurities.**

 

In conjunction with ourinitial public offering in October 2000, we entered into agreementsproviding for additional transfer restrictions with major stockholders, executiveofficers and employee directors.  At eachof the first four anniversaries of our initial public offering, a portion ofthese shares became freely transferable. The final 1,665,400 Class A shares became freely transferable in October 2004.

 

Subsequent to the end offiscal year 2005, in conjunction with our business acquisition of Watson WyattLLP, we issued 9,090,571 Class A shares 4,749,797 of which are subject tosale restrictions.  Sale restrictionswill expire on 2,339,761 shares on the first anniversary and 2,410,036 shareson the second anniversary of the business acquisition.  The payment of up to an additional 1,950,000 Class Ashares after June 30, 2007 is contingent upon achievement by the acquiredbusiness of certain financial performance goals.  Sale of these shares, if issued, will berestricted until the fourth anniversary of the business combination.  See Note 2 of Notes to the ConsolidatedFinancial Statements included in Item 15 of this report for further informationregarding the acquisition of Watson Wyatt LLP.

 

*MarketInformation*

 

Watson Wyatt &Company Holdings Class A common stock is currently traded on the New YorkStock Exchange under the symbol WW.  Thefollowing table sets forth the range of high and low closing share prices foreach quarter of fiscal years 2005 and 2004, determined by the daily closingstock prices.

 
| ** **                                               | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------------------------|------------|----------|------------|----------|------------|
| ** **                                               | ** ** | **High** | ** ** | **Low**  | ** ** | **High** | ** ** | **Low** | ** ** |
|                                                     |       |     |       |     |       |   |   |   |   |
| First quarter (July 1 through September 30)    |       | $        | 26.87      |     | $          | 24.17 |   | $ | 23.49 |   | $ | 22.30 |   |
| Second quarter (October 1 through December 31) |       | 27.48    |       | 25.21    |       | 24.62 |   | 22.75 |   |
| Third quarter (January 1 through March 31)     |       | 28.16    |       | 25.58    |       | 25.43 |   | 22.68 |   |
| Fourth quarter (April 1 through June 30)       |       | 27.55    |       | 24.90    |       | 26.88 |   | 25.13 |   |
|                                                          |            |          |            |          |            |  |  |  |  |  |  |  |  |

 

*Holders*

 

As of June 30, 2005,there were approximately 530 registered shareholders of our Class A commonstock.

 

*Dividends*

 

In May 2004, theBoard of Directors of the company approved the initiation of a quarterly cashdividend in the amount of $0.075 per share. Total dividends paid in fiscal year 2005 were $9.8 million.

 

Subsequent to the end offiscal year 2005 and in conjunction with the acquisition of WWLLP, the companyamended and restated its credit facility (see Note 9 of Notes to theConsolidated Financial Statements, included in Item 15 of this report).  This credit facility requires us to observecertain covenants, including requirements for minimum net worth, which act torestrict dividends.  The continuedpayment of cash dividends in the future is at the discretion of our Board ofDirectors and depends on numerous factors, including, without limitation, ournet earnings, financial condition, availability of capital, debt covenantlimitations and our other business needs, including those of our subsidiariesand affiliates.

 

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##### *Securities Authorized for Issuance Under Equity CompensationPlans*

 

Our equity compensationplans include the 2000 Long-Term Incentive Plan, which provides for thegranting of nonqualified stock options and stock appreciation rights, the 2001Employee Stock Purchase Plan, the 2001 Deferred Stock Unit Plan for SelectedEmployees and the Compensation Plan for Outside Directors.  We grant deferred stock units to certain seniorassociates through the Watson Wyatt & Company Performance Share BonusIncentive Program as a part of their annual discretionary compensation and havediscontinued the issuance of stock options. All deferred stock units issued in connection with the 2001 DeferredStock Unit Plan were fully vested upon issuance.  The company anticipates that the deferredstock units expected to be granted in September 2005 will vestimmediately.  All of our equitycompensation plans have been approved by stockholders.  See Note 10****ofthe Notes to the Consolidated Financial Statements for the general terms ofthese plans.

 

The following chart givesaggregate information regarding grants under all of the Company’s equitycompensation plans through June 30, 2005:

 
| **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 |       | 859,405                                                                       |       | $                                                            | 13.49      |                                                                                                                                                        | 4,443,369  | (1) |
|                                                |       |                                                                          |       |                                                         |       |                                                                                                                                                        |       |
| Total                                               |       | 859,405                                                                       |       | $                                                            | 13.49      |                                                                                                                                                        | 4,443,369  |   |

 

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(1) Includes2,548,915 shares remaining available for future issuance under the 2000 Long-TermIncentive Plan, 942,683 shares under the 2001 Employee Stock Purchase Plan, 912,082shares under the 2001 Deferred Stock Unit Plan for Selected Employees,including 82,941 shares for senior executives under the Performance Share BonusIncentive Program under the Deferred Stock Unit Plan, and 39,689 shares under theCompensation Plan for Outside Directors.

 

In August 2001, theBoard of Directors adopted the company’s 2001 Employee Stock Purchase Plan (the“ESPP”), which subsequently 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 the company’scommon stock.  With regard to theCompensation Plan for Outside Directors, an additional 25,000 shares of commonstock were authorized and reserved for issuance at the 2004 Annual Meeting ofStockholders in November 2004.

 

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*Issuer Purchases of EquitySecurities*

 

Thecompany has repurchased shares of common stock, one purpose of which is tooffset potential dilution from shares issued in connection with the company’sbenefit plans.  In May 2003, thecompany announced a plan to purchase up to 1,150,000 shares of our Class Acommon stock.  The plan does not have anexpiration date.  The table belowpresents specified information about the company’s stock repurchases during thefourth quarter of fiscal year 2005 and the remaining number of shares that maybe purchased under the 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, 2005, through April 30, 2005 |       | —                                 |       | $                                 | —     |                                                                                          | —     |                                                                                       | 763,934    |   |
| May 1, 2005, through May 31, 2005     |       | 200,000                                |       | 25.85                             |       | 200,000                                                                                       |       | 563,934                                                                                    |       |
| June 1, 2005, through June 30, 2005   |       | —                                 |       | —                            |       | —                                                                                        |       | 563,934                                                                                    |       |
| Total                                           |       | 200,000                                |       | $                                 | 25.85      |                                                                                          | 200,000    |                                                                                       |       |   |

 

**Item 6.****           Selected ConsolidatedFinancial Data.**

 

The table on thefollowing page sets forth selected consolidated financial data of WatsonWyatt as of June 30, 2005 and for each of the years in the five-yearperiod ended June 30, 2005.  Theselected consolidated financial data as of June 30, 2005 and 2004, and foreach of the three years in the period ended June 30, 2005, were derivedfrom the audited consolidated financial statements of Watson Wyatt included inthis Form 10-K.  The selectedconsolidated financial data as of June 30, 2003, 2002 and 2001, and foreach of the years ended June 30, 2002 and 2001, were derived from auditedconsolidated financial statements of Watson Wyatt not included in this Form 10-K.

 

The consolidatedfinancial data should be read in conjunction with our Consolidated FinancialStatements and notes thereto and “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” included in Item 7 of this Form 10-K.  Amounts are in thousands of U.S. Dollarsexcept per share data.

 

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| ** **                                                                          | ** ** | **Year Ended June 30** | ** ** |
|-------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                          | ** ** | **2005**                    | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| **Statement  of Operations Data:**(amounts are in thousands, except per share data) |       |                        |       |   |   |   |   |   |   |   |   |
| Revenue                                                                             |       | $                           | 737,421    |   | $ | 702,005 |   | $ | 709,616 |   | $ | 710,480 |   | $ | 700,189 |   |
| Costs of providing services:                                                        |       |                        |       |   |   |   |   |   |   |   |   |
| Salaries and employee benefits                                                      |       | 397,252                     |       | 396,775 |   | 401,274 |   | 404,822 |   | 379,645 |   |
| Professional and subcontracted services                                             |       | 57,810                      |       | 49,159 |   | 47,356 |   | 48,724 |   | 54,089 |   |
| Occupancy, communications and other                                                 |       | 106,752                     |       | 105,459 |   | 106,224 |   | 109,163 |   | 114,417 |   |
| General and administrative expenses                                                 |       | 74,612                      |       | 63,631 |   | 57,285 |   | 55,517 |   | 57,475 |   |
| Depreciation and amortization                                                       |       | 20,210                      |       | 18,511 |   | 19,621 |   | 20,049 |   | 21,995 |   |
|                                                                                |       | 656,636                     |       | 633,535 |   | 631,760 |   | 638,275 |   | 627,621 |   |
| Income from operations                                                              |       | 80,785                      |       | 68,470 |   | 77,856 |   | 72,205 |   | 72,568 |   |
|                                                                                |       |                        |       |   |   |   |   |   |   |   |   |
| Income from affiliates                                                              |       | 7,146                       |       | 7,109 |   | 5,787 |   | 2,866 |   | 3,780 |   |
| Interest income, net                                                                |       | 2,172                       |       | 743 |   | 991 |   | 1,235 |   | 1,711 |   |
| Other non-operating income                                                          |       | (7,404                      | )          | 6,222 |   | 761 |   | 2,166 |   | — |   |
| Income from continuing operations before income  taxes                              |       | 82,699                      |       | 82,544 |   | 85,395 |   | 78,472 |   | 78,059 |   |
| Provision for income taxes                                                          |       | 31,303                      |       | 32,605 |   | 35,015 |   | 31,388 |   | 33,623 |   |
| Income from continuing operations                                                   |       | 51,396                      |       | 49,939 |   | 50,380 |   | 47,084 |   | 44,436 |   |
| Discontinued operations (a)                                                         |       | 766                         |       | 654 |   | 6,786 |   | — |   | — |   |
| Net income                                                                          |       | $                           | 52,162     |   | $ | 50,593 |   | $ | 57,166 |   | $ | 47,084 |   | $ | 44,436 |   |
| Earnings per share, continuing operations, basic                                    |       | $                           | 1.58       |   | $ | 1.52 |   | $ | 1.52 |   | $ | 1.43 |   | $ | 1.39 |   |
| Earnings per share, continuing operations, diluted                                  |       | $                           | 1.56       |   | $ | 1.50 |   | $ | 1.51 |   | $ | 1.41 |   | $ | 1.37 |   |
| Earnings per share, discontinued operations, basic                                  |       | $                           | 0.02       |   | $ | 0.02 |   | $ | 0.21 |   | $ | — |   | $ | — |   |
| Earnings per share, discontinued operations, diluted                                |       | $                           | 0.02       |   | $ | 0.02 |   | $ | 0.21 |   | $ | — |   | $ | — |   |
| Earnings per share, net income, basic                                               |       | $                           | 1.60       |   | $ | 1.54 |   | $ | 1.73 |   | $ | 1.43 |   | $ | 1.39 |   |
| Earnings per share, net income, diluted                                             |       | $                           | 1.58       |   | $ | 1.52 |   | $ | 1.72 |   | $ | 1.41 |   | $ | 1.37 |   |
| Dividend declared per share                                                         |       | $                           | 0.30       |   | $ | 0.07 |   | $ | — |   | $ | — |   | $ | — |   |
| Weighted average shares of common stock, basic                                      |       | 32,541                      |       | 32,866 |   | 32,962 |   | 32,985 |   | 32,068 |   |
| Weighted average shares of common stock, diluted                                    |       | 32,845                      |       | 33,207 |   | 33,287 |   | 33,421 |   | 32,363 |   |

 
|                          |   | **As of June 30** |       |
|-------------------------------|--------|------------------------|------------|
|                          |   | **2005**               | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** |   |
| **Balance Sheet Data:**       |   |                   |       |   |   |   |   |   |   |   |   |
| Cash and cash equivalents     |   | $                      | 168,076    |   | $ | 136,940 |   | $ | 115,674 |   | $ | 87,974 |   | $ | 81,735 |   |
| Working capital               |   | 236,658                |       | 207,455 |   | 169,308 |   | 123,171 |   | 96,171 |   |
| Total assets                  |   | 618,679                |       | 512,168 |   | 514,462 |   | 436,817 |   | 392,016 |   |
| Note payable                  |   | —                 |       | — |   | — |   | — |   | — |   |
| Dividends declared            |   | 9,756                  |       | 2,441 |   | — |   | — |   | — |   |
| Stockholders’ equity (b) |   | 234,203                |       | 245,184 |   | 151,737 |   | 159,221 |   | 111,885 |   |
| Shares outstanding            |   | 32,627                 |       | 32,317 |   | 32,943 |   | 32,897 |   | 33,033 |   |
|                               |        |                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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_______________________________

(a)          Infiscal year 2003, 2004 and 2005, 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, and by $1.25 million, less the associated income taxexpense of $0.5 million, respectively. In fiscal years 2003, 2004 and 2005, the company received subleaseincome of approximately $40,000, $106,000 and $44,000 in excess of lease paymentsrelated to this business.  These items resultedin a year-to-date income from discontinued operations of $11.5 million, $1.1million, and $1.3 million, less the associated income tax expense of $4.7million, $0.5 million and $0.5 million, respectively.

 

(b)         Stockholders’equity includes the after-tax effect of the recording of a minimum pensionliability in fiscal year 2005, 2004 and 2003 of $68,379, $6,651 and $67,869respectively.

 

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

 

**Special Note Regarding Forward-Looking Statements**

 

This filing containscertain statements that are “forward-looking statements” within the meaning ofthe Private Securities Litigation Reform Act of 1995, including, but notlimited to the following: the first paragraph of Part I, Item 3 “LegalProceedings” on pages 19 and 20; “the Executive Overview” on pages 27and 28; the second paragraph under “Revenue Recognition” on page 29; underthe heading “Pension Assumptions” on pages 31 and 32; under the heading “IncurredBut Not Reported Claims” on page 32 ; the paragraph under CapitalCommitments on page 39; under the heading “Risk Management” on page 41;under the subheading “Stock-based Compensation” in Note 1 “Summary ofSignificant Accounting Policies” on pages 59 and 60; the projectedcontribution table in Note 6 “Retirement Benefits” on page 68; the benefitpayments table in Note 6 “Retirement Benefits” on page 72; the benefitpayments table in Note 6 “Retirement Benefits” on page 76; in the secondparagraph of Note 10 “Employee Stock Plans and Equity” on page 78; in thesecond paragraph under the heading “2001 Deferred Stock Unit Plan for SelectedEmployees” in Note 10 on page 81; and in the second and fifth paragraphsof Note 14 “Commitments and Contingent Liabilities” on pages 89 and 90.  In some cases, you can identify thesestatements and other forward-looking statements in this filing by words such as“may,” “will,” “expect,” “anticipate,” “believe,” “estimate,” “plan,” “intend,”“continue” or similar words. You should read these statements carefully becausethey contain projections of our future results of operations or financialcondition, or state other “forward-looking” information.  A number of risks and uncertainties existwhich could cause actual results to differ materially from the resultsreflected in these forward-looking statements. Such factors include, but arenot limited to risks and uncertainties specific to our acquisition of WWLLP,including adverse effects on the market price of the company’s common stock andon the company’s operating results because of failure by the parties tosuccessfully integrate their respective businesses, processes and systems in atimely and cost-effective manner, significant transaction costs expected, unknownliabilities relating to the acquisition or the acquired business, the successof the company’s marketing, development and sales programs following the acquisition,the company’s ability to maintain client relationships and attract new clientsfollowing the acquisition, the company’s ability to achieve cost reductionsafter the acquisition, general economic and business conditions that affect thecompany following the acquisition, the level of capital resources required forongoing operations and future acquisitions, post-closing sales of the company’scommon stock received by former Watson Wyatt LLP partners, and other economic,business, competitive and/or regulatory factors affecting the acquisition, andother factors, including but not limited to, our continued ability to recruitand retain highly qualified associates, outcomes of litigation, a significantdecrease in the demand for the consulting services we offer as a result ofchanging economic conditions or other factors, actions by competitors offeringhuman resources consulting services, including public accounting and consultingfirms, technology consulting firms and internet/intranet development firms,regulatory, legislative and technological developments that may affect thedemand for or costs of our services and other factors discussed under “Risk Factors”in Item 1 of this Form 10-K.  Thesestatements are based on assumptions that may not come true.  All forward-looking disclosure is speculativeby its nature.  The company

 

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undertakes no obligationto 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 globalprovider of human capital consulting services. We provide services in three principal practice areas: Benefits,Technology Solutions and Human Capital consulting, operating from 20 countriesthroughout North America, Asia-Pacific and Latin America.  As of June 30, we also operated throughour affiliates in Europe: Watson Wyatt LLP – which conducted operations in theUnited Kingdom and Ireland and in which we held a 10 percent interest in adefined distribution pool – and Watson Wyatt Holdings (Europe) Limited, aholding company through which we conducted Continental Europeanoperations.  We owned 25 percent ofWatson Wyatt Holdings (Europe) Limited and Watson Wyatt LLP owned the remaining75 percent.  We collectively marketed ourservices globally under the Watson Wyatt Worldwide brand, sharing resources,technologies, processes and business referrals with our alliance partners.

 

Subsequent to the end offiscal year 2005, Watson Wyatt and Watson Wyatt LLP consummated a business acquisition.  As a result, the company assumed 100% ownershipof Watson Wyatt LLP and Watson Wyatt Holdings (Europe) Limited effective July 31,2005.  Since this transaction occurredsubsequent to the end of fiscal year 2005, the Consolidated FinancialStatements and related information contained herein do not reflect the acquisitionexcept where specifically noted otherwise. For more information regarding this business acquisition, see Note 2 ofNotes to the Consolidated Financial Statements included in Item 15 of thisreport.

 

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

 

*BenefitsGroup –*The Benefits Group, accounting for 63 percent of ourtotal 2005 revenues, is the foundation of our business.  Retirement, the core of our Benefitsbusiness, is less impacted by discretionary spending reductions than our othersegments, mainly due to the recurring nature of client relationships.  Our corporate client retention rate withinour target market has remained very high, averaging over 95 percent over thepast two years. Revenue for our retirement practice is seasonal, with the thirdand fourth quarters of each fiscal year being the busier periods.  Major revenue growth drivers in this practiceinclude changes in regulations, particularly those affecting pension plans,leverage from other practices, an improving economy, increased global demandand increased market share.  Revenue fromthe Benefits Group for fiscal year 2005 increased $15.9 million or 4 percentdue to new client wins in the retirement and health care consultingpractices.  Additionally, existing clientrevenues for both practices increased for the year.

 

*TechnologySolutions Group –*Our Technology Solutions Group, accountingfor 10 percent of our total 2005 revenues, provides information technologyservices to our customers.  Revenue fromour Technology Solutions Group decreased $10.8 million or 14 percent duringfiscal year 2005.  Overall consultingactivity was higher, as the decrease reflects time spent customizingadministration systems for which US GAAP precludes us from recognizing revenueduring the system customization efforts. Related revenue will be recognized as these systems go into service.

 

*HumanCapital Group –*Our**Human CapitalGroup, accounting for 8 percent of our total fiscal year 2005 revenues,generally encompasses short-term projects and as a result is most sensitive toeconomic conditions.  Growth slowedsignificantly in the second half of fiscal year 2001 and continued to contractin fiscal years 2002, 2003 and 2004. However, revenue grew by 26 percent

 

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overthe prior-year.  This increase reflectsdemand for executive compensation consulting, strategic rewards consulting andgovernment consulting projects.

 

In the short term, ourrevenues are driven by many factors including the general state of the economyand the resulting level of discretionary spending by our clients, the abilityof our consultants to attract new clients or cross-sell to existing clients,and the impact of new regulations in the legal and accounting fields that mostrecently increased demand for our executive compensation and benefitspractices.

The human resourcesconsulting industry, although highly fragmented, is highly competitive and iscomprised of major human capital consulting firms, specialist firms, consultingarms of accounting firms and information technology consulting firms.  We have successfully managed costs throughoutthe company by leveraging our variable compensation cost structure, initiatingtargeted job reductions and controlling discretionary spending.  We believe we are well-positioned to takeadvantage of an improvement in the overall economy.

 

In the long term, webelieve that benefits spending will continue to be the largest component ofU.S. corporate spending.  We believe thatthe aging workforce, the projected shortfall in workers over the next decadeand changing regulations will translate into opportunities for us.  We believe that the company’s financialresults will depend in large part upon how well we succeed in deepening ourexisting client relationships through thought leadership and focus oncross-practice solutions, actively pursuing new clients in our target markets,cross selling and strategic acquisitions. We believe that the highly- fragmented industry in which we operaterepresents tremendous growth opportunities for us, because we offer a uniquecombination of benefits and human capital consulting as well as strategic technologysolutions.

 

**Financial Statement Overview**

 

The financial statementscontained in this annual report on Form 10-K reflect Watson Wyatt’s ConsolidatedBalance Sheets as of June 30, 2005 and 2004, Consolidated Statements ofOperations for the 12-month periods ended June 30, 2005, 2004 and 2003,Consolidated Statements of Cash Flows for the 12-month periods ended June 30,2005, 2004 and 2003, and a Consolidated Statement of Changes in Stockholders’Equity for the 12-month periods ended June 30, 2005, 2004 and 2003.

 

As further discussed inNote 2 to the Consolidated Financial Statements, on July 31, 2005 weacquired the remaining interest in Watson Wyatt LLP and Watson Wyatt Holdings(Europe) Limited.  However, since thistransaction was consummated subsequent to the end of fiscal year 2005, the ConsolidatedFinancial Statements reflect the results of operations, financial position andcash flows of Watson Wyatt & Company Holdings. Our share of theresults of our affiliates, recorded using the equity method of accounting, isreflected in the “Income from affiliates” line. As of June 30, 2005, ouraffiliates were Watson Wyatt LLP, Watson Wyatt Holdings (Europe) Limited andPCIC, our captive insurance company.

 

We derive substantiallyall of our revenue from fees for consulting services, which generally arebilled at standard hourly rates or on a fixed-fee basis.  Clients are typically invoiced on a monthlybasis with revenue recognized as services are performed. For the most recentthree fiscal years, revenue from U.S. consulting operations has comprisedapproximately 80 percent of consolidated revenue. No single client accountedfor more than four percent of our consolidated revenue for any of the mostrecent three fiscal years.

 

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

 

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Professional andsubcontracted services represent fees paid to external service providers foremployment, marketing and other services. For the most recent three fiscal years, approximately 60 to 70 percentof these professional and subcontracted services were directly incurred onbehalf of our clients and were reimbursed by them, with such reimbursementsbeing included in revenue.

 

Occupancy, communicationsand other expenses represent expenses for rent, utilities, supplies andtelephone to operate office locations as well as non-client-reimbursed travelby associates, publications and professional development. General andadministrative expenses include the operational costs and professional feespaid by corporate management, general counsel, marketing, human resources,finance, research and technology support.

 

**CriticalAccounting Policies and Estimates**

 

The preparation offinancial statements in conformity with accounting principles generally acceptedin the United States of America requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities,disclosures of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenue and expenses during thereporting period.  Our estimates,judgments and assumptions are continually evaluated based on availableinformation and experience.  Because ofthe use of estimates inherent in the financial reporting process, actualresults could differ from those estimates. The accounting policies discussed below are critical to theunderstanding of the use of estimates in the company’s financial statements.

 

***Revenue Recognition***

 

Revenue includes feesprimarily generated from consulting services provided in the areas of employeebenefits, human capital strategies and related technology solutions.  We recognize revenue from these consultingengagements when hours are worked, either on a time-and-materials basis or on afixed-fee basis, depending on the terms and conditions defined at the inceptionof an engagement with a client.  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.

 

Revenue for fixed-feearrangements, which span multiple months, is based upon the percentage ofcompletion method.* *Thecompany typically has three types of fixed-fee arrangements:  annual recurring projects, projects of ashort duration, and non-recurring system projects.  Annual recurring projects and the projects ofshort duration are typically straightforward and highly predictable innature.  As a result, the project managerand financial staff are able to identify, as the project status is reviewed andbills are prepared monthly, the rare occasion when cost overruns could lead tothe recording of a loss accrual.

 

Our non-recurring systemprojects are typically found in our Technology Solutions Group.  They tend to be more complex, to incurchanges in scope as the projects progress and to be longer-term projects.  We evaluate, at least quarterly, and moreoften as needed, project managers’ estimates to complete to assure that theprojects’ current status 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.

 

Revenue recognition forfixed-fee engagements is affected by a number of factors that change theestimated amount of work required to complete the project such as changes inscope, the staffing on the engagement and/or the level of client participation.  The periodic engagement evaluations requireus to make judgments and estimates regarding the overall profitability andstage of project completion that, in turn, affect how we recognizerevenue.  The company recognizes a losson an engagement when estimated revenue to be received for that engagement isless than the total estimated direct and indirect

 

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costs associated with theengagement.  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.  Managementbelieves that it is rare, however, for these excess costs to result in overallproject losses.

 

The company has developed various software programsand technologies that we provide to clients in connection with consultingservices.  In most instances, suchsoftware is hosted and maintained by the company and ownership of thetechnology and rights to the related code remain with the company.  Software developed to be utilized inproviding services to a client, but for which the client does not have thecontractual right to take possession, is capitalized in accordance with theAICPA’s Statement of Position 98-1 “Accounting for the Costs of ComputerSoftware 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 excess of billings is recordedas unbilled accounts receivable.  Cashcollections and invoices generated in excess of revenue recognized are recordedas deferred revenue until the revenue recognition criteria are met.  Client reimbursable expenses, including thoserelating to travel, other out-of-pocket expenses and any third-party costs, areincluded in revenue, and an equivalent amount of reimbursable expenses areincluded in professional and subcontracted services as a cost of revenue.

 

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

 

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

 

We maintain allowancesfor doubtful accounts to reflect estimated losses resulting from our clients’failure to pay for our services after the services have been rendered,including allowances when customer disputes may exist.  The related provision is recorded as areduction to revenue.  Our allowancepolicy is based on the aging of our billed and unbilled client receivables andhas been developed based on our write-off history.  Facts and circumstances such as the averagelength of time the receivables are past due, general market conditions, currenteconomic trends and our clients’ ability to pay may cause fluctuations in ourvaluation of billed and unbilled receivables.

 

***Discretionary Compensation***

 

The company’scompensation program includes a discretionary annual bonus that is determinedby management and paid once per fiscal year in the form of cash and/or deferredstock units after the company’s annual operating results are finalized.

 

An estimated annual bonusamount is initially developed at the beginning of each fiscal year inconjunction with our budgeting process. Quarterly, estimated annual operating performance is reviewed by the companyand the discretionary annual bonus amount is then adjusted, if necessary, bymanagement to reflect changes in the forecast of pre-bonus profitability for theyear.   After determining the estimatedannual bonus amount, the bonus is then allocated to remaining quarterlyreporting periods as a constant

 

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percentage of estimatedpre-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 may vary from currentexpectations as a result of changes in the company’s forecast of pre-bonusprofitability and competitive employment market conditions.

 

As a result of a $5.6million pre-tax non-operating gain recorded in the first quarter of fiscal year2004 related to PCIC, our captive insurance company, the company recorded a$5.6 million supplemental bonus accrual in the first quarter that isincremental to the company’s fiscal year end bonus.  This supplemental bonus amount, which waspaid out in September 2004 with the regular bonus cycle, is included in salariesand employee benefits.  Management doesnot expect this gain or charge to recur.

 

***Income Taxes***

 

Determining theconsolidated provision for income tax expense, deferred tax assets andliabilities and the related valuation allowance involves judgment.  As a global company, we are required tocalculate and provide for estimated income tax liabilities for each of the taxjurisdictions in which we operate.  Thisprocess involves estimating current tax obligations and exposures in eachjurisdiction as well as making judgments regarding the future recoverability ofdeferred tax assets.  Tax costs caninvolve complex issues and may require an extended period to resolve.  Changes in the geographic mix or estimatedlevel of annual pre-tax income, limitations on the use of the company’s foreignsubsidiary losses, changes in tax laws and changes resulting from tax auditscan all affect the overall effective income tax rate which, in turn, impactsthe overall level of income tax expense and net income.

 

***Pension Assumptions***

 

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

 

Pension and OtherPostretirement Employee Benefits (OPEB) costs and obligations are dependent onassumptions used in calculating such amounts. These assumptions include discount rates, health-care cost trend rates,benefits earned, interest cost, expected return on plan assets, mortalityrates, and other factors.  In accordancewith GAAP, actual results that differ from the assumptions are accumulated andamortized over future periods and, therefore, generally affect recognizedexpense and the recorded obligation in future periods.  While management believes that the assumptionsused are appropriate, differences in actual experience or changes inassumptions may affect Watson Wyatt & Company’s pension and otherpostretirement obligations and future expense.

 

The company has establisheda discount rate of 5.25% at year end June 30, 2005, for its U. S.pension and OPEB plans which represents a 100 basis point decrease from the6.25% discount rate used for the prior year. The decrease in the discount rate is the principal reason the company’sU. S. pre-tax pension expense is forecasted to increase from approximately$21 million in fiscal year 2005, excluding any curtailments and settlements, toapproximately $30 million in fiscal year 2006.  The U.S. OPEB plan expense is expected toincrease to $2.5 million for fiscal year 2006 from $2.0 million in fiscal year2005.

 

The expected long-termrate of return on assets assumption remained unchanged at 9.00 percent at theend of fiscal year 2005.  Selection ofthe 9.00 percent return assumption was supported by an analysis performed bythe company of the weighted-average yield expected to be achieved with theanticipated investment allocations, which is heavily weighted towardsequities.  The return on assets in fiscalyear 2005 was 10 percent, compared to a return of 19 percent in fiscal year2004.

 

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The decline in interest rates has increased our accumulated benefitobligation, resulting in the accumulated benefit obligation becoming greaterthan the value of the plan assets for the U.S. qualified pension plans.  Our Canadian non-qualified plan had aliability recognized in the financial statements that was less than theaccumulated benefit obligation.  Bothscenarios above require the company to record an additional minimum pensionliability for those plans in accordance with Statement of Financial AccountingStandards No. 87 “Employers’ Accounting for Pensions” (FAS 87).  This resulted in a pension liability of$105.4 million, intangible assets of $0.6 million, a non-cash charge toStockholders’ Equity of $62.0 million (reflected in accumulated othercomprehensive loss) and an increase in deferred tax assets of $42.8million.  A decrease in long-terminterest rates and/or market deterioration in future periods could make theadditional minimum pension liability larger. Conversely, an increase in long-term interest rates and/or market gainsin future periods could reverse a portion or all of this charge.  Our U.K. plan has had an additional minimumpension liability since fiscal year 2003 and currently represents a liabilityof $9.1 million at June 30, 2005.  OurHong Kong pension plan assets are greater than their associated accumulatedbenefit obligation as of June 30, 2005, and thus does not require the recordingof additional minimum pension liability.

 

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

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

 

Theabove sensitivities reflect the impact of changing one assumption at a time. Itshould be noted that economic factors and conditions often affect multipleassumptions simultaneously and the effects of changes in key assumptions arenot necessarily linear. These changes in assumptions would have no effect onthe company’s funding requirements.  Thecompany’s U.S. Other Postretirement Employee Benefits plan is relativelyinsensitive to discount rate changes due to the plan provisions that have beenestablished to control costs and as such no sensitivity results are shown inthis display.

 

***IncurredBut Not Reported Claims***

 

Thecompany uses actuarial assumptions to estimate and record a liability forincurred but not reported (IBNR) professional liability claims and engaged anexternal actuarial firm to assist in the calculation of these estimates.  Our estimated IBNR liability is based onlong-term trends and averages, and considers a number of factors, includingchanges in claim reporting patterns, claim settlement patterns, judicialdecisions, and legislation and economic decisions, but excludes the effect ofclaims data for large cases due to the insufficiency of actual experience withsuch cases.  Management does notcurrently expect significant fluctuations in the IBNR liability, based on the company’shistorical claims experience.  However,our estimated IBNR liability will fluctuate if claims experience changes overtime.

 

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**Results of Operations**

 

Thefollowing table sets forth Consolidated Statement of Operations data as apercentage of revenue for the periods indicated:

 
| ** **                                             | ** ** | **Year ended June 30** | ** ** |
|--------------------------------------------------------|------------|------------------------|------------|
| ** **                                             | ** ** | **2005**               | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                   |       |                   |       |   |   |   |   |
| Revenue                                                |       | 100.0                  | %          | 100.0 | % | 100.0 | % |
|                                                   |       |                   |       |   |   |   |   |
| Costs of  providing services:                          |       |                   |       |   |   |   |   |
| Salaries and  employee benefits                        |       | 53.9                   |       | 56.5 |   | 56.5 |   |
| Professional and  subcontracted services               |       | 7.8                    |       | 7.0 |   | 6.7 |   |
| Occupancy,  communications and other                   |       | 14.5                   |       | 15.0 |   | 14.9 |   |
| General and  administrative expenses                   |       | 10.1                   |       | 9.1 |   | 8.1 |   |
| Depreciation and  amortization                         |       | 2.7                    |       | 2.6 |   | 2.8 |   |
|                                                   |       | 89.0                   |       | 90.2 |   | 89.0 |   |
|                                                   |       |                   |       |   |   |   |   |
| Income from  operations                                |       | 11.0                   |       | 9.8 |   | 11.0 |   |
|                                                   |       |                   |       |   |   |   |   |
| Income from  affiliates                                |       | 1.0                    |       | 1.0 |   | 0.8 |   |
| Interest income,  net                                  |       | 0.2                    |       | 0.1 |   | 0.1 |   |
| Other  non-operating income                            |       | (1.0                   | )          | 0.9 |   | 0.1 |   |
|                                                   |       |                   |       |   |   |   |   |
| Income from  continuing operations before income taxes |       | 11.2                   |       | 11.8 |   | 12.0 |   |
|                                                   |       |                   |       |   |   |   |   |
| Provision for  income taxes                            |       | 4.2                    |       | 4.7 |   | 4.9 |   |
|                                                   |       |                   |       |   |   |   |   |
| Income from  continuing operations                     |       | 7.0                    | %          | 7.1 | % | 7.1 | % |

 

**Fiscal Year Ended June 30, 2005, Compared toFiscal Year Ended June 30, 2004**

 

***Revenue***

 

Revenues for fiscal year 2005 were $737.4 million, an increase of 5percent from $702.0 million during fiscal year 2004.

 

The Benefits Group increased revenue by $15.9 million or 4 percentduring fiscal year 2005 due to new client wins in the retirement and healthcare consulting practices.  Additionally,existing client revenues for both practices increased for the year.  Revenue from our Technology Solutions Groupdecreased by $10.8 million or 14 percent. Overall consulting activity for this practice was higher, and thedecline in revenue is mainly due to the exclusion of $13.7 million ofconsultant time spent customizing administration systems, in accordance withAICPA’s Statement of Position 98-1.  Revenue from our Human Capital Group increased$11.6 million or 26 percent during fiscal year 2005, reflecting increaseddemand for executive compensation consulting, strategic rewards consulting andgovernment consulting projects.  Ourinternational segment finished the fiscal year with revenue growth of $7.4million or 9 percent.  However, revenuewas up 5% after adjusting for the impact of the weakening U.S. dollar.  International revenue growth for the yearcame largely from China, the Philippines, Taiwan, Mexico and Brazil.  Revenue for other practice areas in NorthAmerica increased by $0.9 million or 2 percent during fiscal year 2005.

 

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***Salariesand Employee Benefits***

 

Salaries and employee benefit expenses for fiscal year 2005 were $397.3million, an increase of $0.5 million from $396.8 million in fiscal year 2004,and decreased as a percentage of revenue to 53.9 percent from 56.5percent.  Salaries and employee benefitexpenses for fiscal year 2004 included severance charges of $3.2 millionrelated to job reductions in North America and the $5.6 million supplementalbonus related to PCIC.  Exclusive ofthese charges, salaries and employee benefit expenses increased $9.3 million,or 2.4%.  The increase, exclusive ofthese charges, was mainly due to a higher accrual for discretionarycompensation of $13.6 million, higher salaries of $6.8 million, higher profitsharing expenses of $3.1 million, which reflects the re-instatement of thecompany’s 401(k) match, and higher benefits expense of $3.1 million, partiallyoffset by the capitalization of time spent customizing in-house administrationsystems of $10.0 million, in accordance with AICPA’s Statement of Position98-1, “Accounting for the Costs of Computer Software Developed or Obtained forInternal Use”, and lower pension and post-retirement costs of $7.4 million.

 

***Professionaland Subcontracted Services***

 

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

 

***Occupancy,Communications and Other***

 

Occupancy, communications and other expenses were $106.8 million forfiscal year 2005, an increase of 1 percent from $105.5 million during fiscalyear 2004, and decreased as a percentage of revenue to 14.5 percent from 15.0percent.  The increase in expenses ismainly due to miscellaneous expenses, including travel, promotional expenses,office supplies, repairs and maintenance and dues and entertainment, partiallyoffset by a reduction in rent and utilities, which is partially due to a leasetermination during fiscal year 2004.

 

***Generaland Administrative Expenses***

 

General and administrative expenses were $74.6 million for fiscal year2005, an increase 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 the government investigations outlined in the legal proceedings section ofthis 10-K.

 

***Depreciationand Amortization***

 

Depreciation and amortization expense was $20.2 million for fiscal year2005, an increase of 9 percent from $18.5 million during fiscal year 2004, andincreased as a percentage 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.

 

***IncomeFrom Affiliates***

 

Income from affiliates remained at $7.1 million for fiscal year 2005 comparedto fiscal year 2004.  During fiscal year2005, our share of operating results of Watson Wyatt LLP increased $1.0million, our share of operating results of WWHE increased $0.4 million, and ourequity income in PCIC decreased $1.5 million.

 

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***InterestIncome, Net***

 

Interest income, net was $2.2 million for fiscal year 2005, an increaseof $1.5 million from $0.7 million during fiscal year 2004.  The increase was due to higher interestearned on our investments as a result of higher interest rates and lowerexpenses due to the reduced size of the credit agreement in existence duringfiscal year 2005.

 

***OtherNon-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 to aclaim by a former joint venture partner, and spent $0.4 million to externaladvisors for strategic consulting.  Non-operatingincome for fiscal year 2004 includes a $5.6 million gain the company recordedin the first quarter of fiscal year 2004 related to PCIC.  See Note 18 of the Notes to the ConsolidatedFinancial Statements for more information about this non-operating gain.  During fiscal year 2004, the company alsoreceived cash payments of $0.6 million in connection with the fiscal year 2002sale 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.

 

***Provisionfor Income Taxes***

 

Provision for income taxes was $31.3million for fiscal year 2005, compared to $32.6 million for the priorperiod.  Our effective tax rate was 37.9percent for fiscal year 2005, compared to 39.5 percent for fiscal year2004.  The change in rate was principallydue to the recognition of US foreign tax credits and the favorable mix ofgeographic income.

 

***IncomeFrom Continuing Operations***

 

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

 

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

 

Diluted earnings per share, income from continuing operations was $1.56for fiscal year 2005, compared to $1.50 for fiscal year 2004.

 

***DiscontinuedOperations***

 

Discontinued operations for fiscal years 2005 and 2004 reflect thereduction of the company’s accrual for the estimated remaining futureobligations and costs related to the exit from Wellspring by $1.25 million and$1.0 million, respectively, less the associated income tax expenses.  Also, during fiscal year 2005 and 2004, thecompany received sublease income of approximately $44,000 and $106,000,respectively, in excess of lease payments related to Wellspring.  See Note 16 of the Notes to the ConsolidatedFinancial Statements for more information related to Wellspring.

 

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**Fiscal Year Ended June 30, 2004, Compared toFiscal Year Ended June 30, 2003**

* *

***Revenue***

 

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

 

The Benefits Group increased revenue by $17.8 million or 4 percentduring fiscal year 2004 due to new client wins, as well as growth in the healthcare consulting group related to retainer contracts and consumer driven healthplan design.  Revenue from our TechnologySolutions Group decreased by $17.3 million or 18 percent, reflecting a delay instarting certain projects as well as the exclusion of $2.7 million ofconsultant time spent customizing administration systems.  Revenue from our Human Capital Groupdecreased $1.6 million or 3 percent during fiscal year 2004, reflectingincreased demand in executive compensation consulting offset by weak results inorganization effectiveness consulting. Our international segment finished the fiscal year with revenue growthof $6.7 million or 9 percent.  However,revenue was up 1 percent after adjusting for the impact of the weakening U.S.dollar.  Revenue for other practice areasin North America decreased by $5.9 million or 12 percent during fiscal year2004.

 

***Salariesand Employee Benefits***

 

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

 

***Professionaland Subcontracted Services***

 

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

 

***Occupancy,Communications and Other***

 

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

 

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***Generaland Administrative Expenses***

 

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

 

***Depreciationand Amortization***

 

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

 

***IncomeFrom Affiliates***

 

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

 

***InterestIncome, Net***

 

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

 

***OtherNon-Operating Income***

 

Other non-operating income was $6.2 million for fiscal year 2004, whichis principally attributable to the $5.6 million non-operating gain the companyrecorded related to PCIC which the company does not expect to recur.  See Note 18 of the Notes to the ConsolidatedFinancial Statements for more information about this non-operating gain.  During fiscal years 2004 and 2003, 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.

 

***Provisionfor Income Taxes***

 

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

 

***IncomeFrom Continuing Operations***

 

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

 

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

 

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

 

***DiscontinuedOperations***

 

Discontinued operations for fiscal years 2004 and 2003 reflect thereduction of the company’s accrual for the estimated remaining futureobligations and costs related to the exit from Wellspring by $1.0 million and$11.4 million, respectively, less the associated income tax expenses.  Also, during fiscal year 2004 and 2003, thecompany received sublease income of approximately $106,000 and $40,000,respectively, in excess of lease payments related to Wellspring.  See Note 16 of the Notes to the ConsolidatedFinancial Statements for more information related to Wellspring.

 

**Liquidity and Capital Resources**

Our cash and cash equivalents and marketable securities at June 30, 2005totaled $168.1 million, compared to $156.9 million at June 30, 2004. Duringfiscal year 2005, we paid $34.8 million in previously accrued discretionarycompensation, $43.4 million in corporate taxes, $34.7 million in capitalexpenditures, contributed $10.0 million to our U.S. defined benefit pensionplan and paid dividends of $9.8 million. These outflows of cash were more than offset by positive cash flow fromconsulting operations.

 

***CashFrom Operating Activities***

 

Cash from operating activities for fiscal year 2005 was $68.1 million,compared to cash from operating activities of $59.5 million for fiscal year 2004.

 

The allowance for doubtful accounts increased $0.9 million and theallowance for work in process decreased $0.2 million from June 30, 2004 to June30, 2005.  The number of days of accountsreceivable and work in process outstanding was 80 at June 30, 2005, up from 78at June 30, 2004.

 

Cash from operating activities for fiscal year 2004 was $59.5 million,compared to cash from operating activities of $74.7 million for fiscal year2003.  The variance is primarily due tothe increase in accounts receivable, the timing of insurance payments andhigher pension accruals (excluding the effect of the minimum pensionliability), net of higher corporate tax payments and higher payments toretirees in fiscal year 2004 and a lower payment of discretionary compensationin fiscal year 2003.

*** ***

***CashUsed in Investing Activities***

 

Cash used in investing activities for fiscal year 2005 was $29.7million, compared to $14.5 million for fiscal year 2004.  The increase can be primarily attributed tohigher purchases of fixed assets of $11.1 million and costs associated with thecapitalization of time spent customizing in-house administration systems of$14.3 million, in accordance with AICPA’s Statement of Position 98-1, and highernet sales and maturities of marketable securities of $11.3 million.  We have made reclassifications to ourConsolidated Statement of Cash Flows for the twelve months ended June 30, 2004to reflect the gross purchases and sales of Dutch auction rate securities asinvesting activities rather than as a component of cash and cashequivalents.  Refer to Note 1 to theConsolidated Financial Statements for additional information.

 

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Cash used in investing activities for fiscal year 2004 was $14.5million, compared to $42.9 million for fiscal year 2003.  We have made reclassifications to ourConsolidated Statement of Cash Flows for the twelve months ended June 30, 2003and 2004 to reflect the gross purchases and sales of Dutch auction ratesecurities as investing activities rather than as a component of cash and cashequivalents.

 

***CashUsed in Financing Activities***

 

Cash used in financing activities was $9.0 million for fiscal year2005, compared to $24.9 million for fiscal year 2004.  The decrease was primarily attributable tofewer repurchases of common stock , which was mainly due to the tender offer duringfiscal year 2004 discussed below and in Note 10, partially offset by dividendspaid during fiscal year 2005.

 

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

** **

**Capital Commitments**

 

Expenditures of capital funds were $59.6 million for fiscal year 2005,including fixed assets of $34.7 million, deferred salary costs of $14.3 millionand dividends of $9.8 million. Anticipated commitments of capital funds for Watson Wyatt are estimatedat $50 million for fiscal year 2006, which includes fixed assets of $26million, dividends of $13 million and deferred software salary costs of $10million. We expect cash from operations to adequately provide for these cashneeds. These capital commitments do not include capital needs for WWLLP infiscal year 2006.

 

**Dividends**

 

In May 2004, the Board of Directors of the company approved theinitiation of a quarterly cash dividend in the amount of $0.075 per share.  Total dividends paid in fiscal year 2005 were$9.8 million.

 

Under our credit facility in effect as of June 30, 2005 (see Note 9 ofNotes to the Consolidated Financial Statements included in Item 15 of thisreport), we are required to observe certain covenants (including requirementsfor a fixed coverage charge, cash flow leverage ratio and asset coverage) thataffect the amounts 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 earnings, financialcondition, availability of capital, debt covenant limitations and our otherbusiness needs, including those of our subsidiaries and affiliates.

 

**Off-Balance Sheet Arrangements and ContractualObligations**

 

***Operating Leases***. We lease office space, furniture and selected computer equipment underoperating lease agreements with terms ranging from one to ten years.  Future expected payments for Watson Wyatt areas follows:

 
| ** **                        | ** ** | **Remaining payments due by fiscal year as of June 30, 2005** | ** ** |
|-----------------------------------|------------|---------------------------------------------------------------|------------|
| **Contractual Cash  Obligations** | ** ** | **Total**                                                     | ** ** | **Less than 1  Year** | ** ** | **2-3 Years** | ** ** | **4-5 Years** | ** ** | **More than  5 Years** | ** ** |
| Lease  commitments                |       | $                                                             | 248,858    |   | $ | 35,113 |   | $ | 63,760 |   | $ | 50,322 |   | $ | 99,663 |   |
|                                   |            |                                                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

 

The figures above do not reflect future lease commitments associatedwith WWLLP’s leases.  Disclosure of WWLLP’slease commitments will be incorporated into the consolidated financialstatements in fiscal year 2006.

 

***Guarantees***

 

*Wellspring Leases*.  The Company continues to guarantee certainleases for office premises and equipment for Wellspring.  At June 30, 2005, minimum remaining paymentsguaranteed under these leases, which expire at various dates through 2007,totaled $11.6 million, excluding anticipated sublease income.  The leases are currently generating positivecash flows of less than $0.1 million per fiscal year.  In the third quarter of fiscal year 2005, thecompany reduced its accrual for the estimated remaining future obligations andcosts related to the exit from Wellspring by $1.25 million, less the associatedincome tax expenses.  Management willcontinue to evaluate the adequacy of these provisions and make adjustments asappropriate.  See Note 16 of the Notes tothe Consolidated Financial Statements for more information related toWellspring.

 

*Affiliate Agreements*.  In connection with the establishment of ouralliance with WWLLP in 1995, the company terminated its then existing officespace in London and a new lease was entered into by WWLLP that expires in2015.  The company agreed to guaranteeWWLLP’s performance under this new lease. However, as a result of the business acquisition between Watson Wyattand Watson Wyatt LLP, this lease will be assumed by Watson Wyatt effective July31, 2005 and will no longer represent a third party guarantee.

 

**Credit Agreement**

 

As of June 30, 2005, Watson Wyatt had a $50 million credit facilityprovided 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.  We are charged a quarterlycommitment fee, currently 0.20 percent of the facility that varies with ourfinancial leverage and is paid on the unused portion of the creditfacility.  No amounts were outstandingunder the company’s revolving credit facility as of June 30, 2005 or 2004.  Credit under the facility is available upondemand, although the credit facility requires us to observe certain covenants(including requirements for a fixed coverage charge, cash flow leverage ratioand asset coverage) and is collateralized with a pledge of stock of material subsidiaries.  We were in compliance with all covenantsunder the credit facility as of June 30, 2005.

 

A portion of the revolving facility is used to support required lettersof credit issued under the credit line. As a result, $7.5 million of the facility was unavailable for operatingneeds as of June 30, 2005.  We are alsocharged a fee for outstanding letters of credit that also fluctuates based onour leverage ratio.

 

In order to secure funding necessary for the business acquisitiondiscussed in Note 2, during July 2005 the company amended and restated itscredit facility to provide for a new revolving credit facility in an aggregateprinciple amount of $300 million. Interest rates associated with this facility vary with LIBOR and/or thePrime Rate and are based on our leverage ratio, as defined by the new creditagreement.  The company also pays a 0.15%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).  The company borrowed $85 million from thiscredit facility in order to fund the acquisition of WWLLP at July 31,2005.  This facility is scheduled tomature on June 30, 2010.

 

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**Risk Management**

 

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

 

In formulating its premium structure, PCIC estimates theamount it expects to pay for losses (and loss expenses) for all the members asa whole and then allocates that amount to the member firms based on theindividual member’s expected losses.  PCICbases premium calculations, which are determined annually based on experiencethrough March of each year, on relative risk of the various lines of businessperformed by each of the owner companies, past claim experience of each ownercompany, growth of each of those companies, industry risk profiles in generaland the overall insurance markets.  As ofJuly 1, 2005, the captive insurance company carries reinsurance for 100% of lossesit insures above $25 million.

 

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

 

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

 

Although the company maintains professional liabilityinsurance coverage, this insurance does not cover claims made after expirationof our current insurance contracts. Generally accepted accounting principles require that we record aliability for incurred but not reported (IBNR) professional liability claims ifthey are estimable and probable, and for which we have not yet contracted forinsurance coverage.  The company usesactuarial assumptions to estimate and record its IBNR liability and has a $13.9million IBNR liability recorded as of June 30, 2005.

 

Recent insurance market conditions for our industry includeincreases in overall premium cost, higher self-insured retentions and constraintson aggregate excess coverages, trends that are anticipated to continue.  We expect these recent conditions to recurperiodically and to be reflected 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 over the past couple of years, with the most recent capitalcontributions ($1.5 million in cash and a letter of credit for $3.1 millionfrom the company) being made in July 2005.

 

In light of increasing worldwide litigation, includinglitigation against professionals, the company has implemented a requirementthat all client relationships be documented by engagement letters containingspecific risk mitigation clauses that were not included in all historicalclient agreements.  Nearly 100 percent ofthe company’s U.S. corporate clients have signed engagement letters includingmitigation clauses, and initiatives to maintain that process both in the UnitedStates and complete it elsewhere are underway. The company has disengaged fromcertain client relationships where satisfactory engagement terms could not beachieved.

 

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**Recent Accounting Pronouncements**

 

In January 2003, the Financial Accounting Standards Board (FASB) issuedFASB Interpretation No. 46 (FIN 46), “Consolidation of Variable InterestEntities,” which clarifies the financial reporting guidance associated with theconsolidation of another entity.  InDecember 2003, the FASB revised and superceded FIN 46 with the issuance of FIN46R in order to address certain implementation issues.  The company adopted FIN 46R effective March31, 2004 and has included appropriate disclosure in this Form 10-K.  Adoption of FIN 46R has not resulted in achange in our accounting.  See Note 4 ofthe Consolidated Financial Statements for further information regarding theimpact of adopting FIN 46R.

 

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

 

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

 

In December 2003, the Financial Accounting Standards Board (FASB)published revisions to Statement of Financial Accounting Standards No. 132, “Employers’Disclosures about Pensions and Other Postretirement Benefits” (SFAS 132).  SFAS 132 revisions retain the originaldisclosures but require additional annual disclosures about assets, obligations,cash flows and interim disclosures about net periodic benefit costs of definedbenefit pension plans and other postretirement plans.   The statement was effective for fiscal yearsending after December 15, 2003.  Thecompany has adopted SFAS 132 as revised and included appropriate disclosure inthe form 10-K.

 

In May 2004, the Financial Accounting Standards Board issued FASB StaffPosition (FSP) No. 106-2 “Accounting and Disclosure Requirements Related to theMedicare Prescription Drug Improvement and Modernization Act of 2003” (the Act)(SFAS 106-2), which was effective as of the first quarter beginning after June15, 2004. The Act includes a prescription drug benefit under Medicare Part D aswell as a federal subsidy to sponsors of retiree health care benefit plans thatprovide a benefit that is at least actuarially equivalent (as defined in theAct) to Medicare Part D.  The adoption ofSFAS 106-2 has not had a material effect on the financial condition or resultsof operations of the company.

 

In June 2004, the Emerging Issues Task Force (EITF) issued EITF 02-14****“Whether an Investor Should Apply the Equity Method ofAccounting to Investments Other Than Common Stock if the Investor Has theAbility to Exercise Significant Influence Over the Operating and FinancialPolicies of the Investee.”  This EITFindicates that an investor should only apply the equity method of accountingwhen it has investments in either common stock or in-substance common stock ofa corporation, provided that the investor has the ability to exercisesignificant influence over the operating and financial policies of theinvestee.  The issuance of EITF 02-14 hasnot had an effect on our accounting for equity investments which has been inaccordance with EITF 02-14.

 

In December 2004, the Financial Accounting Standards Board (FASB)published revisions to Statement of Financial Accounting Standards No. 123, “Accountingfor Stock-Based Compensation” (SFAS 123R). SFAS 123R requirescompanies to account for share-based payment transactions with employees usinga fair-value based method, thereby eliminating the disclosure-only provisionsof SFAS 123.  In April 2005,

 

42

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the SEC issued a rule amending the compliancedate which allows companies to implement SFAS 123R at the beginning of theirnext fiscal year, instead of the next reporting period that begins after June15, 2005.  As a result, the company will implement SFAS 123R in thereporting period starting July 1, 2005.  The company does not expect thatthe adoption will have a material effect on its financial statements.

 

In April 2005, the Securities and Exchange Commission (SEC) issuedStaff Accounting Bulletin No. 107, “Share-Based Payments” (SAB 107) in whichthe SEC expressed views regarding the interaction between SFAS 123R and certainSEC rules and regulations and provide the staff’s views regarding the valuationof share-based payment arrangements for public companies.

 

On October 22, 2004, the American Jobs Creation Act (AJCA) was signedinto law.  The AJCA includes a one-time election to exclude 85 percent offoreign unrepatriated earnings in either fiscal year 2005 or 2006.  The companyhas evaluated the effect of the repatriation provision.  However, it is currently not practical toestimate a range of income taxes associated with any future repatriation.

 

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

We are exposed to market risks in the ordinary course of business.  These risks include interest rate risk andforeign currency exchange risk.  We haveexamined our exposure to these risks and concluded that none of our exposuresin these areas are material to fair values, cash flows or earnings.  See Note 2 of the Notes to the ConsolidatedFinancial Statements for further information regarding our handling of riskassociated with the business acquisition of Watson Wyatt LLP.

 

**Item 8.   Financial Statements and Supplementary Data.**

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

 

**Item 9.   Changes in and Disagreements with Accountants on Accounting and FinancialDisclosure.**

 

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

 

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

 

**Evaluationof Disclosure Controls and Procedures**

 

An evaluation was performed under the supervision andwith the participation of our management, including the chief executiveofficer, or CEO, and chief financial officer, or CFO, of the effectiveness ofthe design and operation of our disclosure procedures. Based on thatevaluation, our management, including the CEO and CFO, concluded that ourdisclosure controls and procedures were effective as of June 30, 2005.

** **

**Changesin Internal Control Over Financial Reporting**

 

There were nosignificant changes in our internal control over financial reporting in thefourth quarter of 2005 that materially affected, or are reasonably likely tomaterially affect, our internal control over financial reporting.

 

43

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**Management’sReport on Internal Control over Financial Reporting**

 

Internal controlover financial reporting refers to the process designed by, or under thesupervision of, our Chief Executive Officer and Chief Financial Officer, and overseenby our board of directors, management and other personnel, to providereasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external purposes in accordance withgenerally accepted accounting principles, and includes those policies andprocedures that: 

 

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

 

(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 controlover financial reporting cannot provide absolute assurance of achievingfinancial reporting objectives because of its inherent limitations. Internalcontrol over financial reporting is a process that involves human diligence andcompliance and is subject to lapses in judgment and breakdowns resulting fromhuman failures. Internal control over financial reporting also can becircumvented by collusion or improper management override. Because of suchlimitations, there is a risk that material misstatements may not be preventedor detected on a timely basis by internal control over financial reporting.However, these inherent limitations are known features of the financialreporting process. Therefore, it is possible to design into the processsafeguards to reduce, though not eliminate, this risk.

 

Management isresponsible for establishing and maintaining adequate internal control overfinancial reporting for the Company. Management has used the framework setforth in the report entitled Internal Control-Integrated Framework published bythe Committee of Sponsoring Organizations (COSO) of the TreadwayCommission to evaluate the effectiveness of the Company’s internal control overfinancial reporting.

 

Management hasconcluded that the Company’s internal control over financial reporting waseffective as of June 30, 2005.

 

Our management’sassessment of the effectiveness of our internal control over financialreporting as of June 30, 2005 has been audited by PricewaterhouseCoopers LLP,an independent registered public accounting firm, as stated in their reportwhich is included herein.

 

**Part III**

 

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

 

The response to this itemwill be included in a definitive proxy statement filed within 120 days afterthe end of the company’s fiscal year, and that information is incorporatedherein by this reference.

 

44

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**Item 11.  Executive Compensation.**

The response to this item will be included in a definitive proxy statementfiled within 120 days after the end of the company’s fiscal year, and that informationis incorporated herein by this reference.

 

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

The response to this item will be included in a definitive proxy statementfiled within 120 days after the end of the company’s fiscal year, and that informationis incorporated herein by this reference.

 

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

****The response to this item will be included in a definitiveproxy statement filed within 120 days after the end of the company’s fiscalyear, and that information is incorporated herein by this reference.

 

**Item 14.  PrincipalAuditor Fees and Services.**

 

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.

 

45

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**Part IV**

 

**Item 15. Exhibits and Financial Statement Schedules**

 
| a)     | Financial Information                                                                                                                                |   |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|   |                                                                                                                                                 |   |
| (1)    | Consolidated Financial Statements of Watson Wyatt  & Company Holdings                                                                            |   |
|   |                                                                                                                                                 |   |
|   | Report of Independent Registered Public Accounting  Firm                                                                                             |   |
|   |                                                                                                                                                 |   |
|   | Financial Statements:                                                                                                                                |   |
|   | Consolidated  Statements of Operations for each of the three years in the period ended June  30, 2005                                                |   |
|   | Consolidated  Balance Sheets at June 30, 2005 and 2004                                                                                               |   |
|   | Consolidated  Statements of Cash Flows for each of the three years in the period ended June  30, 2005                                                |   |
|   | Consolidated Statements of  Changes in Stockholders’ Equity for each of the three years in the period  ended June 30, 2005                      |   |
|   | Notes  to the Consolidated Financial Statements                                                                                                      |   |
|   |                                                                                                                                                 |   |
| (2)    | Consolidated Financial Statement Schedule for each  of the three years in the period ended June 30, 2005                                             |   |
|   |                                                                                                                                                 |   |
|   | 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 96.                                                                                                                        |   |
|   |                                                                                                                                                 |   |
| c)     | Financial Statement Schedules                                                                                                                        |   |
|   |                                                                                                                                                 |   |
|   | Not applicable.                                                                                                                                      |   |

 

46

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**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized.

 
|                  | WATSON WYATT & COMPANY HOLDINGS |
|-----------------------|-------------------------------------|
|                  | (Registrant)                        |
|                  |                                |   |
| Date: August 24, 2005 | By:                                 |   /s/ John J.  Haley |
|                  |                                |   John J.  Haley |
|                  |                                |   President  and Chief Executive Officer |

 

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

 
| **Signature**                | ** ** | **Title**                          | ** ** | **Date** |
|------------------------------|------------|------------------------------------|------------|----------|
|                         |       |                               |       |     |
|                         |       |                               |       |     |
| /s/ John J.  Haley           |       | President, Chief Executive Officer |       | 8/24/05  |
| John J. Haley                |       | and Director                       |       |     |
|                         |       |                               |       |     |
|                         |       |                               |       |     |
| /s/ Carl D.  Mautz           |       | Vice President and Chief           |       | 8/24/05  |
| Carl D. Mautz                |       | Financial Officer                  |       |     |
|                         |       |                               |       |     |
|                         |       |                               |       |     |
| /s/ Peter L.  Childs         |       | Controller                         |       | 8/24/05  |
| Peter L. Childs              |       |                               |       |     |
|                         |       |                               |       |     |
|                         |       |                               |       |     |
| /s/ John J.  Gabarro         |       | Director                           |       | 8/24/05  |
| John J. Gabarro              |       |                               |       |     |
|                         |       |                               |       |     |
|                         |       |                               |       |     |
| /s/ R. Michael  McCullough   |       | Director                           |       | 8/24/05  |
| R. Michael  McCullough       |       |                               |       |     |
|                         |       |                               |       |     |
|                         |       |                               |       |     |
| /s/ Linda D.  Rabbitt        |       | Director                           |       | 8/24/05  |
| Linda D. Rabbitt             |       |                               |       |     |
|                         |       |                               |       |     |
|                         |       |                               |       |     |
| /s/Chandrasekhar  Ramamurthy |       | Director                           |       | 8/24/05  |
| Chandrasekhar  Ramamurthy    |       |                               |       |     |
|                         |       |                               |       |     |
|                         |       |                               |       |     |
| /s/ Gilbert T.  Ray          |       | Director                           |       | 8/24/05  |
| Gilbert T. Ray               |       |                               |       |     |

 

47

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| /s/ John B.  Shoven   |   | Director                    |   | 8/24/05 |
|-----------------------|--------|-----------------------------|--------|---------|
| John B. Shoven        |   |                        |   |    |
|                  |   |                        |   |    |
|                  |   |                        |   |    |
| /s/ Paul N.  Thornton |   | Director                    |   | 8/24/05 |
| Paul N. Thornton      |   |                        |   |    |
|                  |   |                        |   |    |
|                  |   |                        |   |    |
| /s/ Gene H.  Wickes   |   | Vice President and Director |   | 8/24/05 |
| Gene H. Wickes        |   |                        |   |    |
|                  |   |                        |   |    |
|                  |   |                        |   |    |
| /s/ John C.  Wright   |   | Director                    |   | 8/24/05 |
| John C. Wright        |   |                        |   |    |

 

48

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**REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM**

 

To the Board of Directors and Stockholders Watson Wyatt & Company Holdings, Inc.

 

We have completed an integrated audit ofWatson Wyatt & Company Holdings, Inc. 2005 consolidated financialstatements and of its internal control over financial reporting as of June 30,2005 and audits of its 2004 and 2003 consolidated financial statements inaccordance with the standards of the Public Company Accounting Oversight Board(United States).  Our opinions, based on our audits, are presented below.

 

Consolidated financialstatements and financial statement schedule

 

In our opinion, the consolidated financialstatements listed in the accompanying index present fairly, in all materialrespects, the financial position of Watson Wyatt & Company Holdings, Inc.and its subsidiaries at June 30, 2005 and 2004, and the results of theiroperations and their cash flows for each of the three years in the period endedJune 30, 2005 in conformity with accounting principles generally accepted inthe United States of America.  In addition, in our opinion, the financialstatement schedule listed in the accompanying index presents fairly, in allmaterial respects, the information set forth therein when read in conjunctionwith the related consolidated financial statements.  These financialstatements and financial statement schedule are the responsibility of theCompany’s management.  Our responsibility is to express an opinion onthese financial statements and financial statement schedule based on ouraudits.  We conducted our audits of these statements in accordance withthe standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial 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 andsignificant estimates made by management, and evaluating the overall financialstatement presentation.  We believe that our audits provide a reasonablebasis for our opinion.

 

Internal control overfinancial reporting

 

Also, in our opinion, management’sassessment, included in Management’s Report on Internal Control Over FinancialReporting appearing under Item 9A, that the Company maintained effectiveinternal control over financial reporting as of June 30, 2005 based on criteriaestablished in *Internal Control – IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission (COSO), is fairly stated, in all material respects, basedon those criteria. Furthermore, in our opinion, the Company maintained, in allmaterial respects, effective internal control over financial reporting as ofJune 30, 2005 based on criteria established in *InternalControl – Integrated Framework* issued by the COSO.  The Company’smanagement is responsible for maintaining effective internal control overfinancial reporting and for its assessment of the effectiveness of internalcontrol over financial reporting.  Our responsibility is to expressopinions on management’s assessment and on the effectiveness of the Company’sinternal control over financial reporting based on our audit. We conducted ouraudit of internal control over financial reporting in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtainreasonable assurance about whether effective internal control over financialreporting was maintained in all material respects.  An audit of internalcontrol over financial reporting includes obtaining an understanding ofinternal control over financial reporting, evaluating management’s assessment,testing and evaluating the design and operating effectiveness of internalcontrol, and performing such other procedures as we consider necessary in thecircumstances.  We believe that our audit provides a reasonable basis forour opinions.

 

49

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A company’s internal control over financialreporting is a process designed to provide reasonable assurance regarding thereliability of financial reporting and the preparation of financial statementsfor external purposes in accordance with generally accepted accountingprinciples.  A company’s internal control over financial reportingincludes those policies and procedures that (i) pertain to the maintenance ofrecords that, in reasonable detail, accurately and fairly reflect thetransactions and dispositions of the assets of the company; (ii) 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 (iii) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internalcontrol over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periodsare subject to the risk that controls may become inadequate because of changesin conditions, or that the degree of compliance with the policies or proceduresmay deteriorate.

 

PricewaterhouseCoopers LLP McLean, Virginia August 24, 2005

 

50

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**WATSON WYATT & COMPANYHOLDINGS**

**Consolidated Statements ofOperations**

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

 
| ** **                                                                                                                                                                                       | ** ** | **Year Ended June 30** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                       | ** ** | **2005**                    | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                                                                                                                             |       |                        | ** ** |   | ** ** |   | ** ** |
| Revenue                                                                                                                                                                                          |       | $                           | 737,421    |   | $ | 702,005 |   | $ | 709,616 |   |
|                                                                                                                                                                                             |       |                        |       |   |   |   |   |
| Costs of  providing services:                                                                                                                                                                    |       |                        |       |   |   |   |   |
| Salaries and  employee benefits                                                                                                                                                                  |       | 397,252                     |       | 396,775 |   | 401,274 |   |
| Professional and  subcontracted services                                                                                                                                                         |       | 57,810                      |       | 49,159 |   | 47,356 |   |
| Occupancy,  communications and other                                                                                                                                                             |       | 106,752                     |       | 105,459 |   | 106,224 |   |
| General and  administrative expenses                                                                                                                                                             |       | 74,612                      |       | 63,631 |   | 57,285 |   |
| Depreciation and  amortization                                                                                                                                                                   |       | 20,210                      |       | 18,511 |   | 19,621 |   |
|                                                                                                                                                                                             |       | 656,636                     |       | 633,535 |   | 631,760 |   |
|                                                                                                                                                                                             |       |                        |       |   |   |   |   |
| Income from  operations                                                                                                                                                                          |       | 80,785                      |       | 68,470 |   | 77,856 |   |
|                                                                                                                                                                                             |       |                        |       |   |   |   |   |
| Income from  affiliates                                                                                                                                                                          |       | 7,146                       |       | 7,109 |   | 5,787 |   |
| Interest income,  net                                                                                                                                                                            |       | 2,172                       |       | 743 |   | 991 |   |
| Other non-operating  (loss) income                                                                                                                                                               |       | (7,404                      | )          | 6,222 |   | 761 |   |
|                                                                                                                                                                                             |       |                        |       |   |   |   |   |
| Income from  continuing operations before income taxes                                                                                                                                           |       | 82,699                      |       | 82,544 |   | 85,395 |   |
|                                                                                                                                                                                             |       |                        |       |   |   |   |   |
| Provision for  (benefit from) income taxes:                                                                                                                                                      |       |                        |       |   |   |   |   |
| Current                                                                                                                                                                                          |       | 33,725                      |       | 42,722 |   | 47,666 |   |
| Deferred                                                                                                                                                                                         |       | (2,422                      | )          | (10,117 | ) | (12,651 | ) |
|                                                                                                                                                                                             |       | 31,303                      |       | 32,605 |   | 35,015 |   |
|                                                                                                                                                                                             |       |                        |       |   |   |   |   |
| Income from  continuing operations                                                                                                                                                               |       | 51,396                      |       | 49,939 |   | 50,380 |   |
|                                                                                                                                                                                             |       |                        |       |   |   |   |   |
| Discontinued  operations:                                                                                                                                                                        |       |                        |       |   |   |   |   |
|                                                                                                                                                                                             |       |                        |       |   |   |   |   |
| Adjustment to  reduce estimated loss on disposal of discontinued operations, less applicable  income tax expense of $511, $409 and $4,671 for the years ended June 30,  2005, 2004 and 2003 |       | 739                         |       | 592 |   | 6,764 |   |
|                                                                                                                                                                                             |       |                        |       |   |   |   |   |
| Sublease income  from discontinued operations, less applicable income tax expense of $18, $43  and $16 for the years ended June 30, 2005, 2004 and 2003                                     |       | 27                          |       | 62 |   | 22 |   |
|                                                                                                                                                                                             |       |                        |       |   |   |   |   |
| Net income                                                                                                                                                                                       |       | $                           | 52,162     |   | $ | 50,593 |   | $ | 57,166 |   |
|                                                                                                                                                                                             |       |                        |       |   |   |   |   |
| Basic earnings  per share:                                                                                                                                                                       |       |                        |       |   |   |   |   |
| Income from  continuing operations                                                                                                                                                               |       | $                           | 1.58       |   | $ | 1.52 |   | $ | 1.52 |   |
| Income from  discontinued operations                                                                                                                                                             |       | 0.02                        |       | 0.02 |   | 0.21 |   |
| Net income                                                                                                                                                                                       |       | $                           | 1.60       |   | $ | 1.54 |   | $ | 1.73 |   |
|                                                                                                                                                                                             |       |                        |       |   |   |   |   |
| Diluted earnings  per share:                                                                                                                                                                     |       |                        |       |   |   |   |   |
| Income from  continuing operations                                                                                                                                                               |       | $                           | 1.56       |   | $ | 1.50 |   | $ | 1.51 |   |
| Income from  discontinued operations                                                                                                                                                             |       | 0.02                        |       | 0.02 |   | 0.21 |   |
| Net income                                                                                                                                                                                       |       | $                           | 1.58       |   | $ | 1.52 |   | $ | 1.72 |   |
|                                                                                                                                                                                             |       |                        |       |   |   |   |   |
| Weighted average  shares of common stock,                                                                                                                                                        |       |                        |       |   |   |   |   |
| basic (000)                                                                                                                                                                                      |       | 32,541                      |       | 32,866 |   | 32,962 |   |
| Weighted average  shares of common stock,                                                                                                                                                        |       |                        |       |   |   |   |   |
| diluted (000)                                                                                                                                                                                    |       | 32,845                      |       | 33,207 |   | 33,287 |   |

 

See accompanying notes tothe

consolidated financialstatements

 

51

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**WATSON WYATT & COMPANYHOLDINGS**

**Consolidated Balance Sheets**

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

 
| ** **                                                                                                                                             | ** ** | **June 30,** | ** ** | **June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                                                                                                                             | ** ** | **2005**          | ** ** | **2004**          | ** ** |
|                                                                                                                                                   |       |              |       |              |       |
| **Assets**                                                                                                                                             | ** ** | ** **        | ** ** | ** **        | ** ** |
| Cash and cash  equivalents                                                                                                                             |       | $                 | 168,076    |              | $          | 136,940 |   |
| Marketable  securities                                                                                                                                 |       | —            |       | 20,000            |       |
| Receivables from  clients:                                                                                                                             |       |              |       |              |       |
| Billed, net of  allowances of $2,114 and $1,241                                                                                                        |       | 95,977            |       | 86,726            |       |
| Unbilled, net of  allowances of $264 and $456                                                                                                          |       | 62,840            |       | 63,108            |       |
|                                                                                                                                                   |       | 158,817           |       | 149,834           |       |
| Deferred income  taxes                                                                                                                                 |       | 24,718            |       | 15,052            |       |
| Other current  assets                                                                                                                                  |       | 12,599            |       | 11,388            |       |
| Total current  assets                                                                                                                                  |       | 364,210           |       | 333,214           |       |
| Investment in  affiliates                                                                                                                              |       | 30,857            |       | 30,235            |       |
| Fixed assets,  net                                                                                                                                     |       | 94,033            |       | 65,438            |       |
| Deferred income  taxes                                                                                                                                 |       | 92,915            |       | 55,240            |       |
| Goodwill and  intangible assets                                                                                                                        |       | 22,664            |       | 20,909            |       |
| Other assets                                                                                                                                           |       | 14,000            |       | 7,132             |       |
|                                                                                                                                                   |       |              |       |              |       |
| **Total  Assets**                                                                                                                                      |       | $                 | 618,679    |              | $          | 512,168 |   |
| ** **                                                                                                                                             |       |              |       |              |       |
| **Liabilities**                                                                                                                                        | ** ** | ** **        | ** ** | ** **        | ** ** |
| Accounts payable  and accrued liabilities, including discretionary compensation                                                                        |       | $                 | 122,621    |              | $          | 113,233 |   |
| Deferred income  taxes                                                                                                                                 |       | 283               |       | —            |       |
| Income taxes  payable                                                                                                                                  |       | 4,648             |       | 12,526            |       |
| Total current  liabilities                                                                                                                             |       | 127,552           |       | 125,759           |       |
| Accrued  retirement benefits                                                                                                                           |       | 205,029           |       | 97,984            |       |
| Deferred rent  and accrued lease losses                                                                                                                |       | 18,701            |       | 10,199            |       |
| Deferred income  taxes                                                                                                                                 |       | 370               |       | 628               |       |
| Other noncurrent  liabilities                                                                                                                          |       | 32,824            |       | 32,414            |       |
|                                                                                                                                                   |       |              |       |              |       |
| **Total  Liabilities**                                                                                                                                 |       | 384,476           |       | 266,984           |       |
|                                                                                                                                                   |       |              |       |              |       |
| Commitments and  contingencies                                                                                                                         |       |              |       |              |       |
|                                                                                                                                                   |       |              |       |              |       |
| **Stockholders’  Equity**                                                                                                                         |       |              |       |              |       |
| Preferred Stock -  No par value: 1,000,000 shares authorized; none issued and outstanding                                                              |       | —            |       | —            |       |
| Class A  Common Stock - $.01 par value: 69,000,000 shares authorized; 33,372,880 and  33,372,880 issued and 32,627,226 and 32,317,156 outstanding |       | 334               |       | 334               |       |
| Additional paid-in  capital                                                                                                                            |       | 147,948           |       | 149,508           |       |
| Treasury stock,  at cost - 745,654 and 1,055,724 shares                                                                                                |       | (18,705           | )          | (26,149           | )          |
| Retained  earnings                                                                                                                                     |       | 168,075           |       | 125,669           |       |
| Accumulated  other comprehensive loss                                                                                                                  |       | (63,449           | )          | (4,178            | )          |
| **Total  Stockholders’ Equity**                                                                                                                   |       | 234,203           |       | 245,184           |       |
|                                                                                                                                                   |       |              |       |              |       |
| **Total  Liabilities and Stockholders’ Equity**                                                                                                   |       | $                 | 618,679    |              | $          | 512,168 |   |

 

See accompanying notes tothe

consolidated financialstatements

 

52

----

 

**WATSON WYATT & COMPANYHOLDINGS**

**Consolidated Statements of CashFlows**

(Thousands of U.S.Dollars)

 
| ** **                                                                    | ** ** | **Year Ended June 30** | ** ** |
|-------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                    | ** ** | **2005**                    | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                          |       |                        |       |   |   |   |   |
| Cash flows from  operating activities:                                        |       |                        |       |   |   |   |   |
| Net income                                                                    |       | $                           | 52,162     |   | $ | 50,593 |   | $ | 57,166 |   |
| Adjustments to  reconcile net income to net cash from operating activities:   |       |                        |       |   |   |   |   |
| Loss on foreign  currency forward contract                                    |       | 4,803                       |       | — |   | — |   |
| Other  non-operating gain related to PCIC                                     |       | —                      |       | (5,600 | ) | — |   |
| Income from  discontinued operations, net of income tax expense               |       | (739                        | )          | (592 | ) | (6,786 | ) |
| Provision for  doubtful receivables from clients                              |       | 5,563                       |       | 5,612 |   | 7,859 |   |
| Depreciation                                                                  |       | 19,899                      |       | 18,196 |   | 19,205 |   |
| Amortization of  intangible assets                                            |       | 311                         |       | 315 |   | 416 |   |
| Provision for  (benefit from) deferred income taxes                           |       | (4,587                      | )          | (7,457 | ) | 2,994 |   |
| Income from  affiliates                                                       |       | (7,146                      | )          | (7,109 | ) | (5,787 | ) |
| Distributions  from affiliates                                                |       | 6,131                       |       | 5,521 |   | 4,831 |   |
| Other, net                                                                    |       | 866                         |       | 508 |   | (595 | ) |
| Changes in  operating assets and liabilities (net of discontinued operations) |       |                        |       |   |   |   |   |
| Receivables from  clients                                                     |       | (14,546                     | )          | (16,524 | ) | 4,831 |   |
| Other current  assets                                                         |       | (488                        | )          | 377 |   | 5,594 |   |
| Other assets                                                                  |       | (6,868                      | )          | (538 | ) | 1,639 |   |
| Accounts payable  and accrued liabilities                                     |       | 9,532                       |       | 7,359 |   | (14,982 | ) |
| Income taxes  payable                                                         |       | (8,601                      | )          | (3,190 | ) | (3,968 | ) |
| Accrued  retirement benefits                                                  |       | 2,101                       |       | 6,025 |   | (1,855 | ) |
| Deferred rent  and accrued lease losses                                       |       | 8,502                       |       | 5,591 |   | 948 |   |
| Other noncurrent  liabilities                                                 |       | 1,189                       |       | 405 |   | 3,201 |   |
| Net cash from  operating activities                                           |       | 68,084                      |       | 59,492 |   | 74,711 |   |
|                                                                          |       |                        |       |   |   |   |   |
| Cash flows used  in investing activities:                                     |       |                        |       |   |   |   |   |
| Purchases of  marketable securities                                           |       | (469,400                    | )          | (277,600 | ) | (244,700 | ) |
| Sales and  maturities of marketable securities                                |       | 489,400                     |       | 286,300 |   | 224,000 |   |
| Purchases of  fixed assets                                                    |       | (34,712                     | )          | (23,629 | ) | (17,505 | ) |
| Proceeds from  sale of fixed assets                                           |       | 64                          |       | 157 |   | 40 |   |
| Capitalized software  costs                                                   |       | (14,296                     | )          | — |   | — |   |
| Proceeds from  divestitures                                                   |       | 20                          |       | 622 |   | 1,281 |   |
| Acquisitions and  contingent consideration payments                           |       | (812                        | )          | (321 | ) | (2,310 | ) |
| Investments in  affiliates                                                    |       | —                      |       | — |   | (3,661 | ) |
| Net cash used in  investing activities                                        |       | (29,736                     | )          | (14,471 | ) | (42,855 | ) |
|                                                                          |       |                        |       |   |   |   |   |
| Cash flows used  in financing activities:                                     |       |                        |       |   |   |   |   |
| Issuances of  common stock - exercises of stock options                       |       | 1,992                       |       | 2,142 |   | 714 |   |
| Issuances of  common stock - employee stock purchase plan                     |       | 8,078                       |       | 6,789 |   | 6,408 |   |
| Dividends paid                                                                |       | (9,756                      | )          | — |   | — |   |
| Offering costs  on repurchases of common stock                                |       | —                      |       | (728 | ) | — |   |
| Repurchases of  common stock                                                  |       | (9,358                      | )          | (33,139 | ) | (13,824 | ) |
| Net cash used in  financing activities                                        |       | (9,044                      | )          | (24,936 | ) | (6,702 | ) |
|                                                                          |       |                        |       |   |   |   |   |
| Effect of  exchange rates on cash                                             |       | 1,832                       |       | 1,181 |   | 2,546 |   |
|                                                                          |       |                        |       |   |   |   |   |
| Increase in cash  and cash equivalents                                        |       | 31,136                      |       | 21,266 |   | 27,700 |   |
|                                                                          |       |                        |       |   |   |   |   |
| Cash and cash  equivalents at beginning of year                               |       | 136,940                     |       | 115,674 |   | 87,974 |   |
|                                                                          |       |                        |       |   |   |   |   |
| Cash and cash  equivalents at end of year                                     |       | $                           | 168,076    |   | $ | 136,940 |   | $ | 115,674 |   |

 

See accompanying notes totheconsolidated financial statements

 

53

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**WATSON WYATT & COMPANYHOLDINGS**

**Consolidated Statement of Changesin Stockholders’ Equity**

(Thousands of U.S. Dollars)

 
| ** **                                                       | ** ** | **Class A** | ** ** | **Class B-1** | ** ** | **Class B-2** | ** ** | ** **       | ** ** | ** **         | ** ** | ** **         | ** ** | ** **     | ** ** | ** **   | ** ** | ** **       | ** ** | ** **        | ** ** | ** ** | ** ** |
|------------------------------------------------------------------|------------|------------------|------------|--------------------|------------|--------------------|------------|------------------|------------|--------------------|------------|--------------------|------------|----------------|------------|--------------|------------|------------------|------------|-------------------|------------|------------|------------|
| ** **                                                       | ** ** | **Common**       | ** ** | **Common**         | ** ** | **Common**         | ** ** | ** **       | ** ** | ** **         | ** ** | ** **         | ** ** | ** **     | ** ** | ** **   | ** ** | ** **       | ** ** | ** **        | ** ** | ** ** | ** ** |
| ** **                                                       | ** ** | **Stock**        | ** ** | **Stock**          | ** ** | **Stock**          | ** ** | ** **       | ** ** | ** **         | ** ** | ** **         | ** ** | ** **     | ** ** | ** **   | ** ** | **Retained**     | ** ** | **Accumulated**   | ** ** | ** ** | ** ** |
| ** **                                                       | ** ** | **Outstanding**  | ** ** | **Outstanding**    | ** ** | **Outstanding**    | ** ** | **Class A** | ** ** | **Class B-1** | ** ** | **Class B-2** | ** ** | **Additional** | ** ** | **Treasury** | ** ** | **Earnings**     | ** ** | **Other**         | ** ** | ** ** | ** ** |
| ** **                                                       | ** ** | **(number  of**  | ** ** | **(number  of**    | ** ** | **(number  of**    | ** ** | **Common**       | ** ** | **Common**         | ** ** | **Common**         | ** ** | **Paid-in**    | ** ** | **Stock,**   | ** ** | **(Accumulated** | ** ** | **Comprehensive** | ** ** | ** ** | ** ** |
| ** **                                                       | ** ** | **shares)**      | ** ** | **shares)**        | ** ** | **shares)**        | ** ** | **Stock**        | ** ** | **Stock**          | ** ** | **Stock**          | ** ** | **Capital**    | ** ** | **at Cost**  | ** ** | **Deficit)**     | ** ** | **(Loss)/Income** | ** ** | **Total**  | ** ** |
|                                                             |       |             |       |               |       |               |       |             |       |               |       |               |       |           |       |         |       |             |       |              |       |       |       |
| Balance at  June 30, 2002                                   |       | 20,029           |       | —             |       | 12,868             |       | $                | 202        |               | $          | —             |       | $              | 129        |         | $          | 147,034          |       | $                 | (3,076     | )          | $          | 20,351 |   | $ | (5,419 | ) | $ | 159,221 |   |
|                                                             |       |             |       |               |       |               |       |             |       |               |       |               |       |           |       |         |       |             |       |              |       |       |       |
| Comprehensive  loss:                                             |       |             |       |               |       |               |       |             |       |               |       |               |       |           |       |         |       |             |       |              |       |       |       |
| Net income                                                       |       | —           |       | —             |       | —             |       | —           |       | —             |       | —             |       | —         |       | —       |       | 57,166           |       | —            |       | 57,166     |       |
| Additional  minimum pension liability                            |       | —           |       | —             |       | —             |       | —           |       | —             |       | —             |       | —         |       | —       |       | —           |       | (67,869           | )          | (67,869    | )          |
| Foreign currency  translation adjustment                         |       | —           |       | —             |       | —             |       | —           |       | —             |       | —             |       | —         |       | —       |       | —           |       | 4,211             |       | 4,211      |       |
| Total  comprehensive loss                                        |       |             |       |               |       |               |       |             |       |               |       |               |       |           |       |         |       |             |       |              |       | (6,492     | )          |
| Transfer  restriction expiration of 12,745,015 shares            |       | 12,745           |       | —             |       | (12,745            | )          | 127              |       | —             |       | (127               | )          | —         |       | —       |       | —           |       | —            |       | —     |       |
| Other conversion                                                 |       | 123              |       | —             |       | (123               | )          | 2                |       | (2                 | )          | —             |       | —         |       | —       |       | —           |       | —            |       | —     |       |
| Repurchases of  common stock                                     |       | (673             | )          | —             |       | —             |       | —           |       | —             |       | —             |       | —         |       | (13,824      | )          | —           |       | —            |       | (13,824    | )          |
| Issuances of  common stock - employee stock purchase plan shares |       | 393              |       | —             |       | —             |       | —           |       | —             |       | —             |       | (1,347         | )          | 7,755        |       | —           |       | —            |       | 6,408      |       |
| Issuances of  common stock - deferred stock units                |       | 259              |       | —             |       | —             |       | —           |       | —             |       | —             |       | 285            |       | 5,021        |       | —           |       | —            |       | 5,306      |       |
| Issuances of  common stock to outside directors                  |       | 13               |       | —             |       | —             |       | —           |       | —             |       | —             |       | (42            | )          | 249          |       | —           |       | —            |       | 207        |       |
| Issuances of  common stock - stock options                       |       | 54               |       | —             |       | —             |       | —           |       | —             |       | —             |       | (205           | )          | 919          |       | —           |       | —            |       | 714        |       |
| Tax benefit of  exercises of stock options                       |       | —           |       | —             |       | —             |       | —           |       | —             |       | —             |       | 197            |       | —       |       | —           |       | —            |       | 197        |       |
|                                                             |       |             |       |               |       |               |       |             |       |               |       |               |       |           |       |         |       |             |       |              |       |       |       |
| Balance at  June 30, 2003                                   |       | 32,943           |       | —             |       | —             |       | 331              |       | —             |       | —             |       | 145,922        |       | (2,956       | )          | 77,517           |       | (69,077           | )          | 151,737    |       |
|                                                             |       |             |       |               |       |               |       |             |       |               |       |               |       |           |       |         |       |             |       |              |       |       |       |
| Comprehensive  income:                                           |       |             |       |               |       |               |       |             |       |               |       |               |       |           |       |         |       |             |       |              |       |       |       |
| Net income                                                       |       | —           |       | —             |       | —             |       | —           |       | —             |       | —             |       | —         |       | —       |       | 50,593           |       | —            |       | 50,593     |       |
| Additional  minimum pension liability                            |       | —           |       | —             |       | —             |       | —           |       | —             |       | —             |       | —         |       | —       |       | —           |       | 61,218            |       | 61,218     |       |
| Foreign currency  translation adjustment                         |       | —           |       | —             |       | —             |       | —           |       | —             |       | —             |       | —         |       | —       |       | —           |       | 3,681             |       | 3,681      |       |
| Total  comprehensive income                                      |       |             |       |               |       |               |       |             |       |               |       |               |       |           |       |         |       |             |       |              |       | 115,492    |       |
| Cash dividends                                                   |       | —           |       | —             |       | —             |       | —           |       | —             |       | —             |       | —         |       | —       |       | (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    |       |
|                                                                  |            |                  |            |                    |            |                    |            |                  |            |                    |            |                    |            |                |            |              |            |                  |            |                   |            |            |            |  |  |  |  |  |  |  |  |

 

54

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| Comprehensive  income:                                           |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |    |    |    |   |
|------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|---------|--------|---------|---------|---------|--------|
| Net income                                                       |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | 52,162  |   | —  |    | 52,162  |   |
| Additional  minimum pension liability                            |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | —  |   | (61,728 | )       | (61,728 | )      |
| Foreign currency  translation adjustment                         |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | —  |   | 2,457   |    | 2,457   |   |
| Total  comprehensive income                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |    |    | (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 |   |
|                                                                  |        |        |        |        |        |        |        |        |        |        |        |        |        |        |        |        |        |         |        |         |         |         |        |  |  |  |  |  |  |  |  |

 

See accompanying notes tothe

consolidated financialstatements

 

55

----

 

**WATSON WYATT & COMPANYHOLDINGS**

 

**Notes to the ConsolidatedFinancial Statements**

**(Tabular Amounts in Thousands ofU.S. Dollars Except Share and Percentage Data)**

 

**Note 1 - Summary of Significant AccountingPolicies**

 

*Nature of the Business* -Watson Wyatt & Company Holdings (collectively referred to as “we”, “WatsonWyatt” or the “company”), together with our subsidiaries, is an internationalcompany engaged in the business of providing professional consultative serviceson a fee 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.

 

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

 

The Company adopted FIN 46(R) in March 2004, which 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.

 

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

 

*Reclassifications* - Certainamounts previously presented have been reclassified to conform to the currentpresentation.

 

*Cash and Cash Equivalents* -We consider short-term, highly-liquid investments with original maturities of90 days or less to be cash equivalents.  Allof our cash and investments at June 30, 2005 were deemed to be cash and cashequivalents.

In connection with recent interpretationsregarding the classification of auction rate securities, the company concludedthat it was appropriate to classify its auction rate securities as marketablesecurities instead of cash and cash equivalents, which has been the historicalclassification.  Auction rate securitiesare investments that are typically backed by preferred stock or long-term,variable-rate debt instruments whose interest rates are reset at predeterminedshort-term intervals through an auction process. Accordingly, the company hasrevised the classification to report these securities as marketable securities

 

56

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in the Consolidated Balance Sheet as of June30, 2004.  These securities were $20million at June 30, 2004.  The companyhas also made corresponding adjustments to the Consolidated Statement of CashFlows for the year ended June 30, 2004 and 2003, to reflect the gross purchasesof $277.6 million and $244.7 million, respectively, and sales of $286.3 millionand $224.0 million, respectively, of these securities as investing activitiesrather than as a component of cash and cash equivalents. This change inclassification does not affect previously reported cash flows from operationsor from financing activities in the company’s previously reported ConsolidatedStatements of Cash Flows, or the company’s previously reported ConsolidatedStatements of Operations for any period.

 

At June 30, 2005, the company had no auctionrate securities classified as available-for-sale short-term investments,compared to $20.0 million at June 30, 2004. Our investments in these securities have been recorded at cost, whichapproximated fair value due to their variable interest rates, which typicallyreset every 7 to 28 days.  Despite thelong-term nature of their stated contractual maturities, we have had theability to quickly liquidate these securities. As a result, we had no cumulative gross unrealized or realized holdinggains or losses from these investments. All income generated from these investments was recorded as interestincome.

 

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

 

*Revenue Recognition* - Revenueincludes fees primarily generated from consulting services provided in theareas of employee benefits, human capital strategies and related technologysolutions.  We recognize revenue fromthese consulting 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 on a multiple of salary and compensationcosts.

 

Revenue for fixed-fee arrangements, which span multiple months, isbased upon the percentage 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.

 

Our non-recurring system projects are typically found in our TechnologySolutions Group.  They tend to be morecomplex, to incur changes in scope as the project progresses and to belonger-term projects.  We evaluate, atleast quarterly, and more often as needed, project managers’ estimates tocomplete to assure that the projects’ current status is properly accountedfor.  Contracts are written such that, in theunexpected event that the customer terminates a contract, the company gets paidfor work performed through termination.

 

Revenue recognition for fixed-fee engagements is affected by a numberof factors that change the estimated amount of work required to complete theproject such as changes in scope, the staffing on the engagement and/or thelevel of client participation.  Theperiodic engagement evaluations require us to make judgments and estimatesregarding the overall profitability and stage of project completion that, inturn, affect how we recognize revenue. The company recognizes a loss on an engagement when estimated revenue tobe received for that engagement is less than the total estimated direct andindirect costs associated with the engagement. Losses are recognized in the period in which the loss becomes probableand the amount of the loss is reasonably estimable.  The company has experienced certain costs

 

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in excess of estimates from time totime.  It is rare, however, for theseexcess costs to result in overall project losses.

 

The company hasdeveloped various software programs and technologies that we provide to clientsin connection with consulting services. In most instances, such software is hosted and maintained by the companyand ownership of the technology and rights to the related code remain with thecompany.

Software developedto be utilized in providing services to a client, but for which the client doesnot have the contractual right to take possession, is capitalized in accordancewith the AICPA’s Statement of Position 98-1 “Accounting for the Costs ofComputer Software Developed or Obtained for Internal Use.”  Revenue associated with the 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 recognizedin excess of billings is recorded as unbilled accounts receivable.  Cash collections and invoices generated inexcess of 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.

 

In December 2003, the Securities and Exchange Commission (SEC) issuedStaff Accounting Bulletin No. 104 (SAB 104), “Revenue Recognition,” whichsupercedes Staff Accounting Bulletin No. 101 (SAB 101), “Revenue Recognition inFinancial Statements.”  The primarypurpose of SAB 104 is to rescind accounting guidance contained in SAB 101related to multiple element revenue arrangements, superceded as a result of theissuance of Emerging Issues Task Force Issue 00-21, “Revenue Arrangements withMultiple Deliverables” (EITF 00-21). While the wording of SAB 104 has changed to reflect the issuance of EITF00-21, the revenue recognition principles of SAB 101 remain largely unchangedby the issuance of SAB 104.  The issuanceof SAB 104 has not had an effect on our revenue recognition policies as theyare in accordance with SAB 104.

 

*Other Non-operating Expenses***- Non-operating expenses for the year ended June 30,2005 included the settlement cost of $2.2 million related to a claim by aformer joint venture partner, a $4.8 million loss associated with aforeign exchange forward contract entered into in conjunction with the acquisitionof WWLLP (see Note 2) and $0.4 million in fees paid to external advisors forstrategic consulting.

 

*Foreign Currency 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 sheet date.  Revenue and expenses of our subsidiariesoutside the United States are translated into U.S. dollars at the averageexchange rates during the year.  Gainsand losses on translation of our equity interests in our subsidiaries outsidethe United States and on intercompany notes are reported separately asaccumulated other comprehensive loss within stockholders’ equity in theConsolidated Balance Sheets, since we do not plan or anticipate settlement ofsuch balances in the foreseeable future.

 

*Fair Value of Financial Instruments*- The carrying amount of our cash and cash equivalents, short-term investments,receivables from clients and notes and accounts payable approximates fair valuebecause of the short maturity and liquidity of those instruments.  There were no borrowings outstanding underour revolving credit agreement at June 30, 2005 or June 30, 2004.  There were no events of default that wouldrequire us to satisfy the guarantees described in Note 14.

 

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*Concentration of Credit Risk*- Financial instruments that potentially subject the company to concentrationsof credit risk consist principally of certain cash and cash equivalents,short-term investments and receivables from clients.  We invest our excess cash in 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.

 

*Incurred But Not Reported (IBNR) Claims-*The company accrues for IBNR professional liability claims that areestimable and probable, and for which we have not yet contracted for insurancecoverage.  This liability was $13.9million and $13.2 million at June 30, 2005 and 2004, respectively.

 

*Stock-based Compensation* - Wehave elected to follow Accounting Principles Board Opinion No. 25, “Accountingfor Stock Issued to Employees” (APB 25), for stock options issued under the2000 Long-term Incentive Plan and the 2001 Employee Stock Purchase Plan.  Compensation expense for the 2000 Long-termIncentive Plan, if any, would be recorded and measured as the differencebetween the fair market value of the stock at the date of the grant and theoption price.  The compensation expensewould be recognized over the five-year vesting period identified in theplan.  We have elected thedisclosure-only provisions of Statement of Financial Accounting Standards No.123, “Accounting for Stock-Based Compensation” (FAS 123).

 

As required by FAS 123, the company has determined pro forma net incomeand earnings per share as if the company had accounted for its stockcompensation plans under the fair value method of FAS 123.  The company estimated compensation expense forits Stock Purchase Plan based on the discounted purchase price offered toemployees enrolled in the plan, which approximates fair value.  For the Stock Option Plan, the company usesthe Black-Scholes option valuation model to calculate the fair value of optionsgranted for pro forma disclosure purposes. Using the Black-Scholes model, the weighted average fair value ofoptions granted during fiscal year 2002 was $8.00 per option, and $5.26 peroption for fiscal year 2001.  No optionswere granted during fiscal years 2003, 2004 or 2005.  The following assumptions were used in thecalculation:

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

 

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The table below reflects the pro forma effect on net income andearnings per share for fiscal years 2005, 2004 and 2003, as if the company wereto recognize compensation expense under the “fair-value-based method” of SFAS123.

 
| ** **                                                                                                                                    | ** ** | **Year Ended June 30** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                                                                    | ** ** | **2005**               | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                                                                          |       |                   |       |   |   |   |   |
| Net income, as  reported                                                                                                                      |       | $                      | 52,162     |   | $ | 50,593 |   | $ | 57,166 |   |
| Add: Stock-based  compensation expense included in reported net income, net of related tax  effects                                           |       | 241                    |       | 243 |   | 66 |   |
| 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 | ) | (1,518 | ) |
| Pro forma net  income                                                                                                                         |       | $                      | 50,992     |   | $ | 49,174 |   | $ | 55,714 |   |
|                                                                                                                                          |       |                   |       |   |   |   |   |
| Earnings per  share:                                                                                                                          |       |                   |       |   |   |   |   |
| Basic - as  reported                                                                                                                          |       | $                      | 1.60       |   | $ | 1.54 |   | $ | 1.73 |   |
| Basic - pro  forma                                                                                                                            |       | $                      | 1.57       |   | $ | 1.50 |   | $ | 1.69 |   |
|                                                                                                                                          |       |                   |       |   |   |   |   |
| Diluted - as  reported                                                                                                                        |       | $                      | 1.58       |   | $ | 1.52 |   | $ | 1.72 |   |
| Diluted - pro  forma                                                                                                                          |       | $                      | 1.55       |   | $ | 1.48 |   | $ | 1.67 |   |

 

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

 

In December 2002, the FASB issued Statement of Financial AccountingStandards No. 148, “Accounting for Stock-Based Compensation - Transition andDisclosure” (SFAS 148).  SFAS 148provides additional transition guidance for those entities that elect toexpense stock options pursuant to SFAS 123, “Accounting for Stock-BasedCompensation”.  The company has adoptedthe disclosure provisions of SFAS 148 and as a result provides pro formainformation on a quarterly and annual basis regarding stock-based employeecompensation costs.

 

In December 2004, the Financial Accounting Standards Board (FASB)published revisions to Statement of Financial Accounting Standards No. 123, “Accountingfor Stock-Based Compensation” (SFAS 123R). SFAS 123R requirescompanies to account for share-based payment transactions with employees usinga fair-value based method, thereby eliminating the disclosure-only provisionsof SFAS 123.  In April, 2005, the SEC issued a rule amending thecompliance date which allows companies to implement SFAS 123R at the beginningof their next fiscal year, instead of the next reporting period that beginsafter June 15, 2005.  As a result, the company will implement SFAS 123R inthe reporting period starting July 1, 2005.  The company does not expectthat the adoption will have a material effect on its financial statements.

 

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*Earnings per 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.

 

*Goodwill and Intangible Assets*- Watson Wyatt has historically applied the purchase method of accounting toits acquisitions.  In accordance withStatement of Financial Accounting Standards No. 142, “Goodwill and OtherIntangible Assets” (FAS 142), goodwill and indefinite-lived intangible assetsare no longer amortized, but must be assessed at least annually for impairmentbeginning in the year of adoption.  The companyperforms its impairment tests in the third quarter of the company’s fiscalyear, and has determined that no impairment of goodwill has occurred.  FAS 142 also provides that other intangibleassets that have finite useful lives will continue to be amortized over theiruseful lives.  See Note 11 for furtherdisclosures regarding the impact of this pronouncement on our financialresults.

 

*Recent Accounting Pronouncements*- In January 2003, the Financial Accounting Standards Board (FASB) issued FASBInterpretation No. 46 (FIN 46), “Consolidation of Variable Interest Entities,”which clarifies the financial reporting guidance associated with theconsolidation of another entity.  InDecember 2003, the FASB revised and superceded FIN 46 with the issuance of FIN46R in order to address certain implementation issues.  The company adopted FIN 46R effective March31, 2004 and has included appropriate disclosure in this Form 10-K.  Adoption of FIN 46R has not resulted in achange in our accounting.  See Note 4 ofthe Consolidated Financial Statements for further information regarding theimpact of adopting FIN 46R.

 

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

 

In December 2003,the Securities and Exchange Commission (SEC) issued Staff Accounting BulletinNo. 104 (SAB 104), “Revenue Recognition,” which supercedes Staff Accounting BulletinNo. 101 (SAB 101), “Revenue Recognition in Financial Statements.”  SAB 104’s primary purpose is to rescindaccounting guidance contained in SAB 101 related to multiple element revenuearrangements, superceded as a result of the issuance of EITF 00-21.  While the wording of SAB 104 has changed toreflect the issuance of EITF 00-21, the revenue recognition principles of SAB101 remain largely unchanged by the issuance of SAB 104.  The issuance of SAB 104 has not had an effecton our revenue recognition policies as they are in accordance with SAB 104.

 

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

 

In May 2004, the Financial Accounting Standards Board issued FASB StaffPosition (FSP) No. 106-2 “Accounting and Disclosure Requirements Related to theMedicare Prescription Drug Improvement and Modernization Act of 2003” (the Act)(SFAS 106-2), which was effective as of the first quarter beginning after June 15,2004. The Act includes a prescription drug benefit under Medicare Part D aswell as a federal subsidy to sponsors of retiree health care benefit plans thatprovide a benefit that is at least

 

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actuarially equivalent (as defined in the Act) to Medicare Part D.  The adoption of SFAS 106-2 has not had amaterial effect on the financial condition or results of operations of thecompany.

 

In June 2004, the Emerging Issues Task Force (EITF) issued EITF 02-14****“Whether an Investor Should Apply the Equity Method ofAccounting to Investments Other Than Common Stock if the Investor Has theAbility to Exercise Significant Influence Over the Operating and FinancialPolicies of the Investee.”  This EITFindicates that an investor should only apply the equity method of accountingwhen it has investments in either common stock or in-substance common stock ofa corporation, provided that the investor has the ability to exercisesignificant influence over the operating and financial policies of theinvestee.  The issuance of EITF 02-14 hasnot had an effect on our accounting for equity investments which has been inaccordance with EITF 02-14.

 

In December 2004, the Financial Accounting Standards Board (FASB)published revisions to Statement of Financial Accounting Standards No. 123, “Accountingfor Stock-Based Compensation” (SFAS 123R). SFAS 123R requirescompanies to account for share-based payment transactions with employees usinga fair-value based method, thereby eliminating the disclosure-only provisionsof SFAS 123.  In April, 2005, the SEC issued a rule amending thecompliance date which allows companies to implement SFAS 123R at the beginningof their next fiscal year, instead of the next reporting period that beginsafter June 15, 2005.  As a result, the Company will implement SFAS 123R inthe reporting period starting July 1, 2005.  The company does not expectthat the adoption will have a material effect on its financial statements.

 

In April 2005, the Securities and Exchange Commission (SEC) issuedStaff Accounting Bulletin No. 107, “Share-Based Payments” (SAB 107) in whichthe SEC expressed views regarding the interaction between SFAS 123R and certainSEC rules and regulations and provide the staff’s views regarding the valuationof share-based payment arrangements for public companies.

 

On October 22, 2004, the American Jobs Creation Act (AJCA) was signedinto law.  The AJCA includes a one-time election to exclude 85 percent offoreign unrepatriated earnings in either fiscal year 2005 or 2006.  TheCompany has started evaluating the effect of the repatriation provision;however, the company will not be able to complete the analysis until afterCongress or Treasury provides additional guidance on key elements of theprovision.  As a result, it is currently not practical to estimate therange of income taxes associated with repatriation.

 

**Note 2 - Business Acquisition**

 

The company andWatson Wyatt LLP (WWLLP) formed an alliance in 1995 in connection with whichthe company obtained an approximate 20% ownership interest in WWLLP.  On January 18, 2005 the company entered intonon-binding Heads of Agreement setting forth the principal terms of anagreement to acquire substantially all of the assets and assume most liabilitiesof WWLLP. On April 18, 2005, the company announced the signing of a definitiveagreement relating to the transaction.

 

The acquisitionwas completed on July 31, 2005.  Resultsof WWLLP’s operations will be included in the company’s consolidated financialstatements beginning on August 1, 2005 and are not included in the company’sresults for the fiscal year ended June 30, 2005, other than through thecontinued recording of our share of WWLLP’s earnings through the equity methodof accounting as discussed in Note 4. In connection with the acquisition thecompany surrendered its rights and obligations as a member of WWLLP, includingthe right to earnings, if any, after July 31, 2005.

 

The businessacquisition will be accounted for using the purchase method of accounting asprescribed in Statement of Financial Accounting Standards Board No. 141, “BusinessCombinations” (SFAS 141).

 

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The considerationpaid for the assets acquired was approximately £88.3 million in cash and9,090,571 shares of the company’s common stock. In addition, a further1,950,000 shares may be paid after June 30, 2007, contingent upon theachievement by the acquired business of certain agreed-upon financialperformance goals.

 

The cash portionof the purchase price is equal to approximately US$156 million based on theexchange rate on August 1, 2005.  Inaccordance with SFAS 141, the 9,090,571 shares paid will be valued at $26.26per share, the average market price of the company’s stock over the two-dayperiod before and after the terms of the acquisition were agreed to andannounced on January 18, 2005.  Theultimate number of shares of common stock to be issued as contingentconsideration will not be determinable until after June 30, 2007, whenachievement of the financial performance goals is assessed.  The value of any shares issued under thiscontingency will be recorded as goodwill in accordance with SFAS 141.

 

In theacquisition, the company acquired substantially all of the assets of WWLLP,including cash and investments, billed and unbilled receivables from clients,capital assets, identifiable intangible assets and goodwill.  The company also assumed most liabilitiesthat have been incurred by WWLLP in conducting its business, including accountspayable and accrued liabilities, accrued bonuses and unallocated partnershipprofits, leases for properties used by WWLLP, specified contracts in respect ofWWLLP’s business, pension obligations, tax liabilities other than personal taxliabilities of members of WWLLP, and most liabilities of subsidiaries ofWWLLP.  The company did not assumeliabilities and related cash reserves in existence at closing for professionalliability claims relating to work performed before closing by WWLLP, its members,former members, or certain of its indirect subsidiaries. In addition, thecompany did not assume liabilities to make annuity payments to members orformer members, obligations of WWLLP to make payments to former membersrelating to partnership accounts, tax liabilities of members or former membersof WWLLP, liabilities of WWLLP for fees and expenses incurred in connectionwith the acquisition, or liabilities under some contracts.

 

The finalallocation of the purchase price will be determined upon completion of a finalbalance sheet, which includes a final valuation of WWLLP’s tangible andintangible assets and liabilities as of July 31, 2005.  The company is currently in the process ofcompleting a closing balance sheet as of July 31, 2005 through which the valueof these assets and liabilities will be quantified.

 

The company has,however, estimated the value of identifiable intangible assets acquired.  These intangible assets can be broken downinto the following components:

 
| ** **                 | ** ** | **Asset Life**  | ** ** | **Estimated  Amount**           | ** ** |
|----------------------------|------------|-----------------|------------|---------------------------------|------------|
| ** **                 | ** ** | ** **      | ** ** | **(in thousands)  (unaudited)** | ** ** |
| Trademark and  trade name  |       | Not amortizable |       | $                               | 110,900    |   |
| Customer  relationships    |       | 10-15 years     |       | 62,100                          |       |
| Core/developed  technology |       | 3-5 years       |       | 18,300                          |       |
| Total                      |       |            |       | $                               | 191,300    |   |

 

The value of theseintangible assets was estimated by considering cash flows from the currentbalances of accounts, expected growth or attrition in balances, and theestimated life of the relationship and the assigned values are subject tochange as we update this analysis.

 

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In associationwith this business acquisition, the company entered into a foreign currencyforward contract to offset the risk associated with the foreign exchange(Pound) exposure of the cash consideration. The forward contract provided for the purchase of £88.3 million at afixed price of $164.5 million, settling on July 29, 2005.  In accordance with Statement of FinancialAccounting Standards Board No. 133, “Accounting for Derivative Instruments andHedging Activities” (SFAS 133), as amended and interpreted, since the forwardcontract is associated with a business acquisition that is subject to theprovisions of SFAS 141 and the acquisition involves an equity methodinvestment, the forward contract does not qualify for hedge accounting.  As a result, changes in fair value associatedwith the forward contract are recognized in the Consolidated Statement ofOperations.  Consequently, a gain of $1.4million was recognized during the third quarter of fiscal year 2005, and a lossof $6.2 million was recognized during the fourth quarter of fiscal year 2005,for a net loss for fiscal year 2005 of $4.8 million.  The gain and loss associated with thistransaction were included in other non-operating income on the Consolidated Statementof Operations.  The company will recordan additional $3.6 million loss associated with this transaction in the firstquarter of fiscal year 2006.

 

**Note 3 - Cash Flow Information**

 

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

 
| ** **       | ** ** | **Year Ended June 30** | ** ** |
|------------------|------------|------------------------|------------|
| ** **       | ** ** | **2005**               | ** ** | **2004** | ** ** | **2003** | ** ** |
|             |       |                   |       |   |   |   |   |
| Interest expense |       | $                      | 662        |   | $ | 780 |   | $ | 787 |   |
| Income taxes     |       | 43,373                 |       | 43,077 |   | 36,272 |   |
|                  |            |                        |            |  |  |  |  |  |  |  |

 

**Note 4 - Investments in Affiliates**

 

We have historically operated globally as an alliance with ouraffiliates.  As a result, the revenuesand operating expenses in the Consolidated Statements of Operations for fiscalyears 2005, 2004, and 2003 reflect only the results of operations of WatsonWyatt & Company Holdings and do not reflect the acquisition described inNote 2.  Our share of the results of ouraffiliates, recorded using the equity method of accounting, is reflected in the“Income from affiliates” line in the Consolidated Statements of Operations.

 

Entities accounted for under the equity method and our investments inthose affiliates as of June 30, 2005 and 2004 are as follows:

 
| ** **                                        | ** ** | **June 30** | ** ** |
|---------------------------------------------------|------------|-------------|------------|
| ** **                                        | ** ** | **2005**    | ** ** | **2004** | ** ** |
|                                              |       |        |       |   |   |
| Watson Wyatt LLP                                  |       | $           | 17,583     |   | $ | 17,119 |   |
| Watson Wyatt  Holdings (Europe) Limited           |       | 6,998       |       | 6,799 |   |
| Professional  Consultants Insurance Company, Inc. |       | 6,276       |       | 6,317 |   |
|                                              |       |        |       |   |   |
| Total investment  in affiliates                   |       | $           | 30,857     |   | $ | 30,235 |   |

 

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

 

Our principal affiliatesat June 30, 2005 were Watson Wyatt LLP (WWLLP) and Watson Wyatt Holdings(Europe) Limited (WWHE).  On April 1,1995, the company transferred its United Kingdom (“U.K.”) operations to WWLLP, an actuarial partnership based in the U.K., andreceived a beneficial interest in WWLLP and a 10% interest in a defined profitpool of WWLLP.  The company alsotransferred its Continental European operations to WWHE as a newly formed holdingcompany, jointly owned and controlled by the Company and WWLLP, in exchange for50.1% of its shares. Effective July 1, 1998, the company sold one-half of itsinvestment in WWHE to WWLLP.  As of June30, 2005, WWHE was jointly owned and controlled by the company (25%) and WWLLP(75%).  While Watson Wyatt & Company,WWLLP, and WWHE remain separate legal entities, the companies have marketedtheir services globally under the Watson Wyatt Worldwide brand, sharingresources, technologies, processes and business referrals.  We retain the ability to exercise significantinfluence over WWLLP and WWHE.  As ofJune 30, 2005, we had net receivables from WWLLP and WWHE of $0.2 million and$0.1 million, respectively.  As of June30, 2004, we had receivables from WWLLP and WWHE of $0.2 million and $0.2million, respectively.  As disclosed inNote 2, on July 31, 2005 we completed our acquisition of substantially all ofthe remaining assets and assumed most liabilities of WWLLP.

 

Our investment balance inWWHE reflects our initial investment, our 25 percent share of their cumulativenet loss and a note receivable that we carry on our balance sheet atapproximately $7.0 million.  The note iscollateralized by the assets and performance of WWHE and calls for principal andunpaid interest to be paid by 2020.  Inlight of the historical performance of WWHE, the company has not recognizedinterest income for the note.  If thecompany had recognized interest income for the note, its carrying value,including accrued unpaid interest, would approximate £15 million, orapproximately $28 million, as of June 30, 2005. We evaluate the WWHE investment on a quarterly and annual basis and havedetermined that the current carrying value of the WWHE investment isrecoverable as of June 30, 2005. Subsequent to the acquisition described in Note 2, this note will beheld within our U.K. group of subsidiaries.

* *

*Professional ConsultantsInsurance Company, Inc.*

 

Professional ConsultantsInsurance Company, Inc. (PCIC) was organized in 1987 as a captive insurancecompany under the laws of the State of Vermont. PCIC provides professional liability insurance on a claims-made basis tothree actuarial and management consulting firms, all of which participate inthe program as both policyholders and stockholders.

 

Capital contributions toPCIC are required when approved by a majority of its stockholders.  From the time PCIC was organized through June30, 2005, we have contributed $3.9 million in cash and have designated PCIC asthe beneficiary on a total of $4.9 million of letters of credit.  Our ownership interest in PCIC as of June 30,2005 and 2004 was 34.8 percent. Management believes that the company’s maximum financial statementexposure to loss of its investment in PCIC is limited to the carrying value ofthe company’s investment in PCIC of $6.3 million, combined with letters ofcredit totaling $4.9 million for which PCIC has been designated as beneficiary,for a total maximum exposure of $11.2 million.

 

In July 2005, the companycontributed an additional $1.5 million of capital to PCIC and designated PCICas the beneficiary on an additional letter of credit totaling $3.1 million.

 

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Combined summarizedbalance sheet information at June 30 for all of the company’s affiliates is asfollows: 

 
| ** **                                      | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|
|                                            |       |     |       |     |       |
| Current assets                                  |       | $        | 287,166    |     | $          | 272,757 |   |
| Noncurrent assets                               |       | 166,616  |       | 116,815  |       |
|                                            |       |     |       |     |       |
| Total assets                                    |       | $        | 453,782    |     | $          | 389,572 |   |
|                                            |       |     |       |     |       |
| Current liabilities                             |       | $        | 123,550    |     | $          | 77,166 |   |
| Noncurrent liabilities                          |       | 200,866  |       | 162,669  |       |
| Stockholders’ equity                       |       | 129,366  |       | 149,737  |       |
|                                            |       |     |       |     |       |
| Total liabilities and stockholders’ equity |       | $        | 453,782    |     | $          | 389,572 |   |

 

Income from affiliatesincludes our proportionate share of income from these equity investments.  Combined summarized operating results (priorto distribution of profits) reported by the affiliates for the years ended June30 are as follows:

 
| ** **           | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------|------------|----------|------------|----------|------------|----------|------------|
|                 |       |     |       |     |       |     |       |
| Revenue              |       | $        | 495,264    |     | $          | 423,783  |       | $ | 354,890 |   |
| Operating  expenses  |       | 373,423  |       | 294,260  |       | 254,752  |       |
|                 |       |     |       |     |       |     |       |
| Income before  taxes |       | 121,841  |       | 129,523  |       | 100,138  |       |
|                 |       |     |       |     |       |     |       |
| Net income           |       | $        | 121,612    |     | $          | 127,152  |       | $ | 97,607 |   |
|                      |            |          |            |          |            |          |            |  |  |  |  |

 

The Company adopted FIN46(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.

 

We have evaluated underFIN 46(R) our consolidated subsidiaries and both Wellspring and GRS and believethat our accounting and disclosure is in compliance with the pronouncement.

 

66

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**Note 5 - Fixed Assets**

 

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

 

The components of fixedassets are:

 
| ** **                                       | ** ** | **June 30** | ** ** |
|--------------------------------------------------|------------|-------------|------------|
| ** **                                       | ** ** | **2005**    | ** ** | **2004** | ** ** |
|                                             |       |        |       |   |   |
| Furniture,  fixtures and equipment               |       | $           | 85,994     |   | $ | 78,588 |   |
| Computer  software                               |       | 58,184      |       | 33,414 |   |
| Leasehold improvements                           |       | 52,695      |       | 44,454 |   |
|                                             |       | 196,873     |       | 156,456 |   |
| Less:  accumulated depreciation and amortization |       | (102,840    | )          | (91,018 | ) |
|                                             |       |        |       |   |   |
| Fixed assets,  net                               |       | $           | 94,033     |   | $ | 65,438 |   |

 

Total unamortizedcomputer software costs were $45.1 million and $25.1 million as of June 30,2005 and 2004, respectively.  Totalamortization expense for computer software was $5.1 and $2.2 million for fiscalyear 2005 and 2004, respectively.

 

**Note 6— Retirement Benefits**

 

*Defined Benefit Plans*

 

We sponsor both qualifiedand non-qualified, non-contributory defined benefit pension plans coveringsubstantially all of our associates. Under our principal plans (United States, Canada, Hong Kong and U.K.),benefits are based on the number of years of service and the associates’compensation during the five highest paid consecutive years of service.  The non-qualified plan provides for pensionbenefits that would be covered under the qualified plan but are limited by theInternal Revenue Code.  The non-qualifiedplan has no assets and therefore is an unfunded arrangement which is reflectedin the balance sheet.  Included in theresults is our U.K. plan, which is inactive but is part of the additionalminimum pension liability reported on the Consolidated Balance Sheets.  The measurement date for the plans is June30.

 

67

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Funding is based onactuarially determined contributions and is limited to amounts that arecurrently deductible for tax purposes. Since funding calculations are based ondifferent measurements than those used for accounting purposes, pensioncontributions are not equal to net periodic pension cost.  The excess of net periodic pension cost oversuch contributions and direct benefit payments under non-qualified planprovisions is accrued by the company. The following table sets forth our projected voluntary pensioncontributions for fiscal year 2006, as well as the voluntary pensioncontributions to our various plans in fiscal years 2005 and 2004:

 
| ** ** | ** ** | **2006 (Projected)** | ** ** | **2005 (Actual)** | ** ** | **2004 (Actual)** | ** ** |
|------------|------------|----------------------|------------|-------------------|------------|-------------------|------------|
| U.S.       |       | 10,000               |       | 10,000            |       | 10,000            |       |
| Canada     |       | 2,500                |       | 2,431             |       | 46                |       |
| Hong Kong  |       | 1,100                |       | 1,009             |       | 1,039             |       |
| U.K.       |       | 800                  |       | 848               |       | 1,262             |       |

 

The fair value of planassets is based on the market value of domestic equity, international equityand fixed income securities that are in the pension portfolio.  To the extent the expected return on thepension portfolio varies from the actual return, there is an unrecognized gainor loss.

 

The non-current portionsof accrued costs related to our principal retirement plans reflected in thecompany’s Consolidated Balance Sheets are:

 
| ** **                                   | ** ** | **June 30** | ** ** |
|----------------------------------------------|------------|-------------|------------|
| ** **                                   | ** ** | **2005**    | ** ** | **2004** | ** ** |
|                                         |       |        |       |   |   |
| Defined benefit  retirement plans            |       | $           | 151,990    |   | $ | 44,313 |   |
| Canadian  Separation Allowance Plan          |       | 4,067       |       | 4,878 |   |
| Postretirement  benefits other than pensions |       | 48,972      |       | 48,793 |   |
|                                         |       |        |       |   |   |
| Accrued  retirement benefits                 |       | $           | 205,029    |   | $ | 97,984 |   |

 

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

 
| ** **                                                  | ** ** | **Year Ended June 30** | ** ** |
|-------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                  | ** ** | **2005**               | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                        |       |                   |       |   |   |   |   |
| Discount rate, Projected Benefit Obligation                 |       | 5.25                   | %          | 6.25 | % | 6.00 | % |
| Discount rate, Net Periodic Benefit Cost                    |       | 6.25                   | %          | 6.00 | % | 7.25 | % |
| Expected  long-term rate of return on assets                |       | 9.00                   | %          | 9.00 | % | 9.00 | % |
| Rate of increase in compensation, PBO                       |       | 3.34                   | %          | 3.34 | % | 3.09 | % |
| Rate of increase in compensation, Net Periodic Benefit Cost |       | 3.34                   | %          | 3.09 | % | 4.34 | % |

 

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

 

68

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The expected long-termrate of return on assets assumption remained at 9.00 percent at June 30,2005.  Continuation of the 9.00 percentreturn assumption was supported by an analysis performed by the company of theweighted average yield expected to be achieved with the anticipated makeup ofinvestments.  The investment portfolio isheavily weighted towards equities.

 

The company calculatesthe net periodic benefit costs for a given fiscal year based on assumptionsestablished at the end of the previous fiscal year.  Actuarial gains and losses associated withchanging any of these assumptions are not recognized immediately; instead theyare accumulated as part of the unrecognized net loss/(gain)balance and amortized into the net periodic pension expense over the averageremaining service period of participating employees.

 

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

 
| ** **                              | ** ** | **Year Ended June 30** | ** ** |
|-----------------------------------------|------------|------------------------|------------|
| ** **                              | ** ** | **2005**               | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                    |       |                   |       |   |   |   |   |
| Service cost                            |       | $                      | 25,202     |   | $ | 26,674 |   | $ | 26,201 |   |
| Interest cost                           |       | 36,457                 |       | 33,490 |   | 33,564 |   |
| Expected return on plan assets          |       | (42,580                | )          | (35,831 | ) | (37,466 | ) |
| Amortization of transition obligation   |       | (7                     | )          | (4 | ) | 199 |   |
| Amortization of net unrecognized losses |       | 6,989                  |       | 11,406 |   | 4,760 |   |
| Amortization of prior service cost      |       | (2,161                 | )          | (2,169 | ) | 582 |   |
|                                    |       |                   |       |   |   |   |   |
| Net periodic  pension cost              |       | $                      | 23,900     |   | $ | 33,566 |   | $ | 27,840 |   |

 

The following tablesummarizes benefit obligations associated with the qualified and non-qualifiedplans:

 
| ** **                                        | ** ** | **June 30, 2005** | ** ** | **June 30, 2004** | ** ** |
|---------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                        | ** ** | **Qualified**     | ** ** | **Non-qualified** | ** ** | **Qualified** | ** ** | **Non-qualified** | ** ** |
|                                              |       |              |       |              |       |   |   |   |   |
| Accumulated benefit obligation                    |       | $                 | 592,823    |              | $          | 73,131 |   | $ | 469,549 |   | $ | 61,172 |   |
|                                              |       |              |       |              |       |   |   |   |   |
| Projected benefit obligation at beginning of year |       | $                 | 508,725    |              | $          | 78,490 |   | $ | 486,225 |   | $ | 80,318 |   |
| Service cost                                      |       | 19,896            |       | 5,306             |       | 21,081 |   | 5,593 |   |
| Interest cost                                     |       | 31,518            |       | 5,031             |       | 28,704 |   | 4,786 |   |
| Actuarial losses/(gains)                          |       | 85,607            |       | 13,740            |       | (15,828 | ) | 297 |   |
| Benefit payments                                  |       | (16,975           | )          | (1,418            | )          | (15,608 | ) | (1,476 | ) |
| Change in assumptions                             |       | 10,042            |       | 1,389             |       | — |   | — |   |
| Settlements                                       |       | 253               |       | (11,100           | )          | — |   | (10,542 | ) |
| Other                                             |       | 845               |       | —            |       | 1,580 |   | (613 | ) |
| Foreign currency adjustment                       |       | 2,794             |       | 1,175             |       | 2,574 |   | 128 |   |
| Projected benefit obligation at end of year       |       | $                 | 642,705    |              | $          | 92,613 |   | $ | 508,728 |   | $ | 78,491 |   |

 

69

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The table below providesinformation for the U.S. qualified pension plan with an accumulated benefitobligation in excess of plan assets in fiscal year 2005.  In fiscal year 2004, the U.S. qualified planassets were greater than the accumulated benefit obligation.  The non-qualified amounts reflect only theU.S. and Canadian plans and are unfunded.

 
| ** **                      | ** ** | **June 30, 2005** | ** ** | **June 30, 2004** | ** ** |
|---------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                      | ** ** | **Qualified**     | ** ** | **Non-qualified** | ** ** | **Qualified** | ** ** | **Non-qualified** | ** ** |
|                            |       |              |       |              |       |   |   |   |   |
| Projected  Benefit Obligation   |       | $                 | 554,746    |              | $          | 92,613 |   | $ | 440,820 |   | $ | 78,491 |   |
| Accumulated  Benefit Obligation |       | 512,162           |       | 73,131            |       | 406,397 |   | 61,172 |   |
| Fair value of  plan assets      |       | 445,002           |       | —            |       | 407,776 |   | — |   |
|                                 |            |                   |            |                   |            |  |  |  |  |  |  |  |  |

 

The table below providesinformation for the UK pension plan with an accumulated benefit obligation inexcess of plan assets in fiscal years 2005 and 2004.

 
| ** **                      | ** ** | **June 30, 2005** | ** ** | **June 30, 2004** | ** ** |
|---------------------------------|------------|-------------------|------------|-------------------|------------|
|                            |       |              |       |              |       |
| Projected  Benefit Obligation   |       | $                 | 26,867     |              | $          | 25,997 |   |
| Accumulated  Benefit Obligation |       | 26,867            |       | 25,997            |       |
| Fair value of  plan assets      |       | 21,147            |       | 19,107            |       |
|                                 |            |                   |            |                   |            |  |  |

 

The Canada and Hong Kongqualified plans each had assets greater than the accumulated benefitobligation.

 

The following tablesummarizes plan assets associated with the qualified and non-qualified plans:

 
| ** **                                     | ** ** | **June 30, 2005** | ** ** | **June 30, 2004** | ** ** |
|------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                     | ** ** | **Qualified**     | ** ** | **Non-qualified** | ** ** | **Qualified** | ** ** | **Non-qualified** | ** ** |
|                                           |       |              |       |              |       |   |   |   |   |
| Fair value of plan assets at beginning of year |       | $                 | 476,022    |              | $          | — |   | $ | 405,339 |   | $ | — |   |
| Actual return on plan assets                   |       | 49,537            |       | —            |       | 71,986 |   | — |   |
| Company contributions                          |       | 14,288            |       | 12,518            |       | 12,347 |   | 12,018 |   |
| Benefit payments                               |       | (16,975           | )          | (12,518           | )          | (15,628 | ) | (12,018 | ) |
| Participant contributions                      |       | 845               |       | —            |       | — |   | — |   |
| Foreign currency adjustment                    |       | 3,170             |       | —            |       | 1,978 |   | — |   |
| Fair value of plan assets at end of year       |       | $                 | 526,888    |              | $          | — |   | $ | 476,022 |   | $ | — |   |

 

70

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The following table, andthe narrative that follows, provide information relating to theweighted-average asset allocations at June 30, 2005 and 2004 and the investmentstrategy for the company’s U.S. defined benefit pension plan, which comprisesthe majority of our define benefit pension plans: 

 
| ** **         | ** ** | **Plan Assets at June 30** | ** ** |
|--------------------|------------|----------------------------|------------|
| ** **         | ** ** | **2005**                   | ** ** | **2004** | ** ** |
| Asset Category     |       |                       |       |   |   |
| Equity  securities |       | 84.5                       | %          | 85.8 | % |
| Debt securities    |       | 15.5                       | %          | 14.2 | % |
| Real estate        |       | 0.0                        | %          | 0.0 | % |
| Other              |       | 0.0                        | %          | 0.0 | % |
| Total              |       | 100                        | %          | 100 | % |

 

The investment objectivesof the company’s qualified pension plan are designed to generate returns thatwill enable the plan to meet its future obligations. The precise amount forwhich these obligations will be settled depends on future events, including thelife expectancy of the plan’s members and salary inflation. The obligations areestimated using actuarial assumptions, based on the current economicenvironment.

 

The pension plan seeks toachieve total returns both sufficient to meet expected future obligations aswell as returns greater than its policy benchmark reflecting the target weightsof the asset classes used in its targeted strategic asset allocation.  The plan’s targeted strategic allocation toeach asset class was determined through an Asset-Liability Modeling study toevaluate long-term asset-allocation strategy. This comprehensive study provides an evaluation of the projected statusof asset and liability measures for the plan under a range of both positive andnegative environments.  The studyincludes a number of different asset mixes, spanning a range of diversificationand potential equity exposures.

 

In evaluating thestrategic asset allocation choices, an emphasis is placed on the long-termcharacteristics of each individual asset class, and the benefits ofdiversification among multiple asset classes. Consideration is also given tothe proper long-term level of risk for the plan, particularly with respect tothe long-term nature of the plan’s liabilities, the impact of asset allocationon investment results, and the corresponding impact on the volatility andmagnitude of plan contributions and expense and the impact certain actuarialtechniques may have on the plan’s recognition of investment experience.  The currently adopted strategic assetallocation targets 85 percent in equity securities and 15 percent in debt securitiesincluding additional allocations within specific asset classes of these broadcategories.

 

The company monitorsinvestment performance and portfolio characteristics on a quarterly basis toensure that managers are meeting expectations with respect to their investmentapproach.  With the exception ofsecurities issued by the U.S. Government and its agencies, no single issue isto comprise more than 5 percent of the portfolio’s value although index fundmanagers are exempt from the security weighting constraints. There are alsovarious restrictions and controls placed on managers including prohibition frominvesting in company stock.

 

The expected return onassets assumption is developed in conjunction with advisors and using thecompany’s asset model that reflects a combination of rigorous historicalanalysis and the forward looking views of the financial markets as revealedthrough the yield on long-term bonds, the price earnings ratios of the majorstock market indices and long-term inflation. Amounts are tested forreasonableness against their historical averages. The assumption was loweredfrom 10.0 percent to 9.0 percent for the fiscal year beginning July 1, 2003.The expected return on assets assumption is intended to be a long-termassumption and is not expected to be modified frequently.  The return on assets in fiscal year 2005 was10 percent, compared to a return of 19 percent in fiscal year 2004.

 

71

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The following benefitpayments for our defined benefit pension plan, which reflect expected futureservice, as appropriate, are expected to be paid:

 

| **Fiscal  Year**  | ** ** | **Benefit  payments** | ** ** |
|-------------------|------------|-----------------------|------------|
|              |       |                  |       |
| 2006              |       | $                     | 21,269     |   |
| 2007              |       | 23,773                |       |
| 2008              |       | 25,748                |       |
| 2009              |       | 30,792                |       |
| 2010              |       | 30,658                |       |
| Years 2011 - 2015 |       | 199,005               |       |
|              |       | $                     | 331,245    |   |

 

The following tablesummarizes the funding status associated with the qualified and non-qualifiedplans:

 
| ** **                                 | ** ** | **June 30, 2005** | ** ** | **June 30, 2004** | ** ** |
|--------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                 | ** ** | **Qualified**     | ** ** | **Non-qualified** | ** ** | **Qualified** | ** ** | **Non-qualified** | ** ** |
|                                       |       |              |       |              |       |   |   |   |   |
| Funded status at end of year               |       | $                 | (115,815   | )                 | $          | (92,613 | ) | $ | (32,702 | ) | $ | (78,491 | ) |
| Unrecognized prior service cost            |       | (7,489            | )          | (3,248            | )          | (9,375 | ) | (3,579 | ) |
| Unrecognized net loss/(gain)               |       | 177,824           |       | 7,679             |       | 95,876 |   | (7,721 | ) |
| Unrecognized transition obligation/(asset) |       | (209              | )          | 166               |       | (247 | ) | 209 |   |
| Net amount recognized                      |       | $                 | 54,311     |              | $          | (88,016 | ) | $ | 53,552 |   | $ | (89,582 | ) |

 

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

 

During fiscal year 2003,the value of the assets held in the pension plans decreased and the decline ininterest rates increased our accumulated benefit obligation, resulting in theaccumulated benefit obligation becoming greater than the value of the planassets for the U.S. and U.K. pension plans. The company was therefore required to record an additional minimumpension liability for those plans at June 30, 2003, in accordance withStatement of Financial Accounting Standards No. 87 “Employers’ Accounting forPensions” (FAS 87).  This resulted in anincrease in the pension liability of $113.4 million, an increase in intangibleassets of $0.1 million, a non-cash charge to Stockholders’ Equity of $67.9million (reflected in accumulated other comprehensive loss) and an increase indeferred tax assets of $45.4 million as of June 30, 2003.

 

In fiscal year 2004, thevalue of the assets held in the pension plans in the U.S. increased due tomarket appreciation, resulting in the value of the plan assets becoming greaterthan the accumulated benefit obligation, thereby eliminating the requirement torecord an additional minimum pension liability for the U.S. plans. Thisresulted in a decrease in the pension liability of $105.4 million, a reductionin the charge to Stockholders’ Equity of $62.4 million (reflected in accumulatedother comprehensive loss) and a decrease in deferred tax assets of $43.1million as of June 30, 2004. The value of the assets held in the pension planin the U.K. remained below the accumulated benefit obligation, resulting in theaccumulated benefit obligation remaining greater than the value of the planassets for U.K. pension plan.  Anadditional liability of $1.7 million, a non-cash charge to Stockholders’ Equityof $1.2 million (reflected in

 

72

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accumulatedother comprehensive loss) and an increase in deferred tax assets of $0.5million as of June 30, 2004 was recorded for the U.K.

 

In fiscal year 2005, thedecline in interest rates has increased our accumulated benefit obligation,resulting in the accumulated benefit obligation becoming greater than the valueof the plan assets for the U.S pension plans. Our Canadian non-qualified plan had a liability recorded in thefinancial statements that was less than its accumulated benefit obligation.  As a result, in both scenarios above, the companywas required to record an additional minimum pension liability for those plansin accordance with Statement of Financial Accounting Standards No. 87“Employers’ Accounting for Pensions” (FAS 87). This resulted in an increase in the pension liability of $105.4 million,an increase in intangible assets of $0.6 million, a non-cash charge toStockholders’ Equity of $62.0 million (reflected in accumulated othercomprehensive loss) and an increase in deferred tax assets of $42.8 million.  Our U.K. plan currently has an additionalminimum pension liability recorded of $9.1 million at June 30, 2005.  Our Canadian and Hong Kong qualified pensionplan assets were greater than their associated accumulated benefit obligationas of June 30, 2005 and 2004 and thus did not require the recording ofadditional minimum pension liabilities in either period.

 

As of June 30, 2005, our ConsolidatedBalance Sheets reflect the recording of a minimum pension liability of $114.8million, an intangible asset of $0.6 million, an accumulated othercomprehensive loss of $68.4 million (reflected in Stockholders’ Equity) and adeferred tax asset of $45.8 million.

 

The table belowsummarizes the amounts reflected in our Consolidated Balance Sheets for theperiod indicated:

 
| ** **                             | ** ** | **June 30, 2005** | ** ** | **June 30, 2004** | ** ** |
|----------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                             | ** ** | **Qualified**     | ** ** | **Non-qualified** | ** ** | **Qualified** | ** ** | **Non-qualified** | ** ** |
|                                   |       |              |       |              |       |   |   |   |   |
| Prepaid (accrued) benefit cost         |       | $                 | 54,311     |              | $          | — |   | $ | 53,552 |   | $ | — |   |
| Accrued benefit liability              |       | (112,842          | )          | (89,723           | )          | (9,625 | ) | (89,582 | ) |
| Intangible assets                      |       | 122               |       | 486               |       | 124 |   | — |   |
| Accumulated other comprehensive income |       | 112,720           |       | 1,221             |       | 9,501 |   | — |   |
| Net amounts recognized                 |       | $                 | 54,311     |              | $          | (88,016 | ) | $ | 53,552 |   | $ | (89,582 | ) |

 

*Defined Contribution Plans*

 

We sponsor a savings planthat provides benefits to substantially all U.S. associates.  Effective July 1, 2004, the companyreinstituted a match to employee contributions at a rate of 50% of the first 6%up to $60,000 of associates’ eligible compensation.  The company will also make an annual profitsharing contribution to the plan in an amount that is dependant upon thecompany’s financial performance during the fiscal year.  The company contribution in fiscal year 2005was $3.0 million.

 

On July 1, 2003, thecompany match was suspended.   Under theplan in previous years, we had matched employee contributions at 50 percent ofthe first 6 percent of total pay, which includes base salary, overtime andannual performance-based bonuses. Vesting of the company match occurs after three years for new employeesand is 100 percent for all employees hired before January 1, 1997.  The expense in fiscal years 2003 was $7.4million.  Under the plan, we also havethe ability to make discretionary profit-sharing contributions.  We made no profit-sharing contributionsduring fiscal years 2004 or 2003.  Wealso sponsor a Canadian Separation Allowance Plan (CSAP) that providesretirement benefits to

 

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substantiallyall Canadian associates.  The CSAP is anunfunded benefit plan; as such, the amounts due to associates are recorded as aliability in the Consolidated Balance Sheets of the company.  CSAP expense for fiscal years 2005, 2004 and2003 amounted to $192,000, $243,000 and $264,000, respectively.

* *

*Health Care Benefits*

 

We sponsor a contributoryhealth care plan that provides hospitalization, medical and dental benefits tosubstantially all U.S. associates.  Weaccrue a liability for estimated incurred but unreported claims based onprojected use of the plan as well as prior plan history.  The liability totaled $2.3 million at June30, 2005 and 2004, and is included in accounts payable and accrued liabilitiesin the Consolidated Balance Sheets.

* *

*Postretirement Benefits*

 

We provide certain healthcare and life insurance benefits for retired associates.  The principal plans cover associates in theU.S. and Canada who have met certain eligibility requirements. Our principalplans are unfunded.

 

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

 
| ** **                                                            | ** ** | **Year Ended June 30** | ** ** |
|-----------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                            | ** ** | **2005**               | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                  |       |                   |       |   |   |   |   |
| Health care cost trend, accumulated benefit obligation:               |       |                   |       |   |   |   |   |
| Pre-65 benefits  (decreasing to 5.00% for 2010 and thereafter)        |       | 10.00                  | %          | 9.00 | % | 10.00 | % |
| Post-65 benefits  (decreasing to 5.00% for 2010 and thereafter)       |       | 10.00                  | %          | 9.00 | % | 10.00 | % |
| Discount rate, accumulated benefit obligation  postretirement benefit |       | 5.25                   | %          | 6.25 | % | 6.00 | % |

 

Actuarial gains andlosses associated with changing any of the assumptions are accumulated as partof the unrecognized net gain balance which is amortized and included in the net periodic postretirement costsover the average remaining service period of participating employees, which isapproximately 16 years.

 

A one percentage pointchange in the assumed health care cost trend rates would have the followingeffect:

 
| ** **                                                                   | ** ** | **1% Increase** | ** ** | **1% Decrease** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------|------------|-----------------|------------|
|                                                                         |       |            |       |            |       |
| Effect on net periodic postretirement benefit cost in fiscal year 2005       |       | $               | 298        |            | $          | (213 | ) |
| Effect on accumulated postretirement benefit obligation as of June 30,  2005 |       | 2,543           |       | (2,108          | )          |
|                                                                              |            |                 |            |                 |            |  |  |

 

74

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Net periodicpostretirement benefit cost consists of the following components reflected asexpense in the company’s Consolidated Statements of Operations:

 
| ** **                                | ** ** | **Year Ended June 30** | ** ** |
|-------------------------------------------|------------|------------------------|------------|
| ** **                                | ** ** | **2005**               | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                      |       |                   |       |   |   |   |   |
| Service cost                              |       | $                      | 1,556      |   | $ | 1,686 |   | $ | 1,769 |   |
| Interest cost                             |       | 2,414                  |       | 2,300 |   | 2,514 |   |
| Amortization of transition obligation     |       | 77                     |       | 47 |   | 46 |   |
| Amortization of net unrecognized gains    |       | (362                   | )          | (274 | ) | (516 | ) |
| Amortization of prior service cost        |       | (659                   | )          | (624 | ) | (464 | ) |
|                                      |       |                   |       |   |   |   |   |
| Net periodic  postretirement benefit cost |       | $                      | 3,026      |   | $ | 3,135 |   | $ | 3,349 |   |

 

The following table setsforth the changes in the accumulated postretirement benefit obligation:

 
| ** **                              | ** ** | **June 30** | ** ** |
|-----------------------------------------|------------|-------------|------------|
| ** **                              | ** ** | **2005**    | ** ** | **2004** | ** ** |
|                                    |       |        |       |   |   |
| Benefit obligation at beginning of year |       | $           | 40,150     |   | $ | 39,545 |   |
| Service cost                            |       | 1,556       |       | 1,686 |   |
| Interest cost                           |       | 2,414       |       | 2,300 |   |
| Participant contributions               |       | 266         |       | 207 |   |
| Actuarial gains                         |       | (870        | )          | (1,794 | ) |
| Benefit payments                        |       | (3,186      | )          | (2,637 | ) |
| Other                                   |       | 1,011       |       | 769 |   |
| Foreign currency adjustment             |       | 705         |       | 74 |   |
| Benefit obligation at end of year       |       | $           | 42,046     |   | $ | 40,150 |   |

 

The following table setsforth the changes in the company contributions and benefit payments for thepostretirement plan:

 
| ** **                                     | ** ** | **June 30** | ** ** |
|------------------------------------------------|------------|-------------|------------|
| ** **                                     | ** ** | **2005**    | ** ** | **2004** | ** ** |
|                                           |       |        |       |   |   |
| Fair value of plan assets at beginning of year |       | $           | —     |   | $ | — |   |
| Company contributions                          |       | 2,920       |       | 2,430 |   |
| Participant contributions                      |       | 266         |       | 207 |   |
| Benefit payments                               |       | (3,186      | )          | (2,637 | ) |
| Fair value of plan assets at end of year       |       | $           | —     |   | $ | — |   |

 

75

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The following benefitpayments for our postretirement plan, which reflect expected future service, asappropriate, are expected to be paid:

 

| **Fiscal  Year**  | ** ** | **Benefit  payments** | ** ** |
|-------------------|------------|-----------------------|------------|
|              |       |                  |       |
| 2006              |       | $                     | 2,154      |   |
| 2007              |       | 2,250                 |       |
| 2008              |       | 2,350                 |       |
| 2009              |       | 2,439                 |       |
| 2010              |       | 2,545                 |       |
| Years 2011 - 2015 |       | 14,346                |       |
|              |       | $                     | 26,084     |   |

 

The following table setsforth the changes in the funded status in the postretirement plan:

 
| ** **                            | ** ** | **June 30** | ** ** |
|---------------------------------------|------------|-------------|------------|
| ** **                            | ** ** | **2005**    | ** ** | **2004** | ** ** |
|                                  |       |        |       |   |   |
| Funded status at end of year          |       | $           | (42,046    | ) | $ | (40,150 | ) |
| Unrecognized prior service cost       |       | (6,149      | )          | (6,508 | ) |
| Unrecognized net gain                 |       | (3,701      | )          | (4,987 | ) |
| Unrecognized transition obligation    |       | —      |       | 426 |   |
| Net accrued postretirement  liability |       | $           | (51,896    | ) | $ | (51,219 | ) |

 

The unrecognized priorservice cost represents the cumulative prior service costs and benefits fromamendments to the postretirement plan which has not yet been recognized in thefinancial statements.  Previous amendmentsare being amortized and included in the net periodic postretirement benefitcosts over the average remaining service period of participating employees,which is approximately eight years.

 

Based on the FinancialAccounting Standards Board Staff Position No. 106-2 “Accounting and DisclosureRequirements Related to the Medicare Prescription Drug Improvement andModernization Act of 2003” (FAS 106-2), plans meeting the definition ofactuarial equivalence can begin to reflect drug subsidies that will be providedin 2006 under Medicare (Part D).  Theliabilities determined as of June 30, 2005 for disclosure purposes reflectthese changes. The adoption of FAS 106-2 does not have a material effect onliabilities above.

 

76

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**Note 7 - Accounts Payable andAccrued Liabilities**

 

Accounts payable andaccrued liabilities consist of:

 
| ** **                                                                                           | ** ** | **June 30** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|-------------|------------|
| ** **                                                                                           | ** ** | **2005**    | ** ** | **2004** | ** ** |
|                                                                                                 |       |        |       |   |   |
| Accounts payable and accrued liabilities                                                             |       | $           | 37,707     |   | $ | 35,617 |   |
| Accrued salaries and bonuses                                                                         |       | 49,055      |       | 42,655 |   |
| Current portion of defined benefit retirement plans and postretirement  benefits other than pensions |       | 4,531       |       | 7,170 |   |
| Accrued vacation                                                                                     |       | 15,716      |       | 15,482 |   |
| Advance billings deferred revenue                                                                    |       | 13,172      |       | 9,868 |   |
| Dividends payable                                                                                    |       | 2,440       |       | 2,441 |   |
| Total accounts payable and accrued liabilities                                                       |       | $           | 122,621    |   | $ | 113,233 |   |

 

**Note 8 - Leases**

 

We lease office space,furniture and selected computer equipment under operating lease agreements withterms generally ranging from one to ten years. We have entered into sublease agreements for some of our excess leasedspace.  Rental expense was $51.8 million,$56.1 million, and $52.8 million for fiscal years 2005, 2004 and 2003,respectively, inclusive of operating expenses related to such space andequipment.  Sublease income was $0, $0.6million and $0.5 million for fiscal years 2005, 2004 and 2003, respectively.

 

Future minimum leasepayments for Watson Wyatt’s operating lease commitments and anticipated cashinflows for sublease income are:

 
| **Fiscal** | ** ** | **Lease**       | ** ** |
|------------|------------|-----------------|------------|
| **Year**   | ** ** | **Commitments** | ** ** |
|       |       |            |       |
| 2006       |       |            | $          | 35,113 |   |
| 2007       |       |            | 33,814     |   |
| 2008       |       |            | 29,946     |   |
| 2009       |       |            | 26,300     |   |
| 2010       |       |            | 24,022     |   |
| Thereafter |       |            | 99,663     |   |
| Total      |       |            | $          | 248,858 |   |

 

We evaluate office capacity on an ongoing basisto meet changing needs in our markets while minimizing our occupancy expense.

 

The figures above do not reflect future leasecommitments and cash inflows from sublease income associated with WWLLP’sleases.  Disclosure of WWLLP’s leasecommitments and cash flows from sublease income will be incorporated into the ConsolidatedFinancial Statements in fiscal year 2006.

 

77

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**Note 9 - Line of Credit**

 

As of June 30, 2005,Watson Wyatt had a $50 million credit facility provided by a syndicate ofbanks.  Interest rates associated withthis facility vary with LIBOR and/or the Prime Rate and are based on ourleverage ratio, as defined by the credit agreement.  We are charged a quarterly commitment fee,currently 0.20 percent of the facility that varies with our financial leverageand is paid on the unused portion of the credit facility.  No amounts were outstanding under thecompany’s revolving credit facility as of June 30, 2005 or June 30, 2004.  Credit under the facility is available upondemand, although the credit facility requires us to observe certain covenants(including requirements for a fixed coverage charge, cash flow leverage ratioand asset coverage) and is collateralized with a pledge of stock of materialsubsidiaries.  We were in compliance withall covenants under the credit facility as of June 30, 2005.

 

A portion of therevolving facility is used to support required letters of credit issued underthe credit line.  As a result, $7.5million of the facility was unavailable for operating needs as of June 30,2005.  We are also charged a fee foroutstanding letters of credit that also fluctuates based on our leverage ratio.

 

In order to securefunding necessary for the business acquisition discussed in Note 2, on July 11,2005, the company amended and restated its credit facility to provide for a newrevolving credit facility in an aggregate principle amount of $300million.  Interest rates associated withthis facility vary with LIBOR and/or the Prime Rate and are based on ourleverage ratio, as defined by the new credit agreement.  The company also pays a 0.15% commitment feeon the unused portion of the facility. Credit under the facility is available upon demand, although the creditfacility requires us to observe certain covenants (including requirements forminimum net worth, which act to restrict dividends, cash flow leverage ratioand a fixed coverage charge).  Thecompany borrowed $85 million from this credit facility on July 29, 2005 inorder to fund the acquisition of WWLLP. This facility is scheduled to mature on June 30, 2010.

 

**Note 10 - Employee Stock Plansand Equity**

* *

*2000 Long-Term Incentive Plan*

 

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

 

The stock optionagreements have a seven-year life and vest 20 percent at each optionanniversary date over a five-year period. All options under the Stock Option Plan were granted with an exerciseprice equal to the stock’s fair market value on the date of grant.  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.

 

78

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The table below presentsstock option activity since June 30, 2002:

 
| ** **                    | ** ** | ** **          | ** ** | **Weighted** | ** ** |
|-------------------------------|------------|---------------------|------------|--------------|------------|
| ** **                    | ** ** | ** **          | ** ** | **Average**  | ** ** |
| ** **                    | ** ** | **Number of**       | ** ** | **Exercise** | ** ** |
| ** **                    | ** ** | **Shares**          | ** ** | **Price**    | ** ** |
| ** **                    | ** ** | **(in 000’s)** | ** ** | ** **   | ** ** |
|                          |       |                |       |         |       |
| Outstanding at  June 30, 2002 |       | 1,539               |       | $            | 13.51      |   |
| Granted                       |       | —              |       | —       |       |
| Exercised                     |       | (54                 | )          | 12.63        |       |
| Forfeited                     |       | (143                | )          | 14.60        |       |
| Expired                       |       | —              |       | —       |       |
|                          |       |                |       |         |       |
| Outstanding at  June 30, 2003 |       | 1,342               |       | $            | 13.43      |   |
| Granted                       |       | —              |       | —       |       |
| Exercised                     |       | (164                | )          | 12.91        |       |
| Forfeited                     |       | (106                | )          | 13.91        |       |
| Expired                       |       | —              |       | —       |       |
|                          |       |                |       |         |       |
| Outstanding at  June 30, 2004 |       | 1,072               |       | $            | 13.45      |   |
| Granted                       |       | —              |       | —       |       |
| Exercised                     |       | (154                | )          | 13.00        |       |
| Forfeited                     |       | (59                 | )          | 13.99        |       |
| Expired                       |       | —              |       | —       |       |
|                          |       |                |       |         |       |
| Outstanding at  June 30, 2005 |       | 859                 |       | $            | 13.49      |   |

 

79

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At June 30, 2005, therewere 652,541 options exercisable at a weighted average price of $13.44.  The table below presents additionalinformation about the options outstanding and exercisable at June 30, 2005:

 
| ** **         | ** ** | **Outstanding Options** | ** ** | **Exercisable Options** | ** ** |
|--------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **         | ** ** | ** **              | ** ** | **Weighted**            | ** ** | **Average** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **         | ** ** | **Number**              | ** ** | **Average**             | ** ** | **Remaining** | ** ** | **Number** | ** ** | **Average** | ** ** |
| **Range of**       | ** ** | **of**                  | ** ** | **Exercise**            | ** ** | **Contractual** | ** ** | **of** | ** ** | **Exercise** | ** ** |
| **Exercise Price** | ** ** | **Shares**              | ** ** | **Price**               | ** ** | **Life (years)** | ** ** | **Shares** | ** ** | **Price** | ** ** |
| ** **         | ** ** | **(in 000’s)**     | ** ** | ** **              | ** ** | ** ** | ** ** | **(in 000’s)** | ** ** | ** ** | ** ** |
|               |       |                    |       |                    |       |   |   |   |   |   |   |
| $10.00             | -          | $15.00                  |       | 761                     |       | $ | 12.50 |   | 2.2 |   | 581 |   | $ | 12.50 |   |
| $15.01             | -          | $20.00                  |       | 30                      |       | $ | 17.87 |   | 2.5 |   | 23 |   | $ | 17.88 |   |
| $20.01             | -          | $25.00                  |       | 66                      |       | $ | 22.49 |   | 2.6 |   | 48 |   | $ | 22.40 |   |
| $25.01             | -          | $30.00                  |       | 2                       |       | $ | 26.50 |   | 2.9 |   | 1 |   | $ | 26.50 |   |
|               |       |                    |       |                    |       |   |   |   |   |   |   |   |   |
| $10.00             | -          | $30.00                  |       | 859                     |       | $ | 13.49 |   | 2.2 |   | 653 |   | $ | 13.44 |   |

 

*2001 Employee Stock Purchase Plan*

 

The 2001 Employee StockPurchase Plan (the “Stock Purchase Plan”) was approved at the annualstockholders’ meeting in November 2001. The Stock Purchase Plan, which qualifies as an “employee stock purchaseplan” under Section 423 of the Internal Revenue Code of 1986 of the UnitedStates of America, originally provided for the issuance of up to 750,000 sharesof the company’s common stock.  In April2003, the Board of Directors approved an additional 1,500,000 shares forissuance under this plan.  The companygained stockholder approval for issuance of these additional shares at ourannual meeting in November 2003. Full-time and regular part-time employees are eligible to participate inthe Stock Purchase Plan through payroll deductions of up to 10 percent of eachparticipant’s compensation, subject to certain restrictions.  Shares of common stock acquired pursuant tothe Stock Purchase Plan may not be disposed of by the participant for at leastthree months following the exercise date.

 

Certain provisions of theStock Purchase Plan were revised  in order to comply with the accountingprovisions of SFAS 123R and were approved by the Board of Directors on February18, 2005.  Prior to these changes, underthe plan, offering periods were held every three months beginning each November1, February 1, May 1 and August 1.  Thepurchase price for shares of common stock to be purchased during any offeringperiod was 85 percent of the lower of the fair market value of common stock onthe beginning or ending date of each offering period.  Subsequent to changes approved by the Boardof 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.

 

A summary of stockpurchased under the Stock Purchase Plan is shown below for fiscal years 2005and 2004:  

 
| ** **                                | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|
|                                      |       |     |       |     |       |
| Aggregate  purchase price (in 000’s) |       | $        | 7,734      |     | $          | 6,789 |   |
| Shares purchased  (in 000’s)         |       | 362      |       | 360      |       |
| Employee  participants                    |       | 1,071    |       | 1,138    |       |
|                                           |            |          |            |          |            |  |  |

 

80

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

 

In November 2001, the2001 Deferred Stock Unit Plan for Selected Employees (the “Stock Unit Plan”)was approved at the annual meeting of stockholders.  The Stock Unit Plan is intended to providesenior associates of the company with additional incentives by permitting thecompany to grant them an equity interest in the company in the form of deferredstock units, in lieu of a portion of their annual fiscal year end bonus,typically paid in September of each year. Each stock unit represents one shareof common stock.  The total number ofshares authorized for issuance in payment of deferred stock units under theStock Unit Plan is 1,500,000 shares.

 

Deferred stock units weregranted in September 2002, 2003 and 2004 and vested immediately.  The company expects that the deferred stockunits expected to be granted in September 2005 will vest immediately. Vestingof future awards is at the discretion of the company, with such determinationbeing made prior to issuance of the deferred stock units.

 

InNovember 2004, the Board of Directors of the Company approved the establishmentof and grants under a new long-term bonus arrangement pursuant to the Company’s2001 Deferred Stock Unit Plan for Selected Employees, which was approved byshareholders in 2001.  The new arrangement, called the Performance ShareBonus Incentive Program (the “SBI Program”), is a long-term stock bonusarrangement for senior executives of the Company and its affiliates that isdesigned to strengthen incentives and align behaviors to grow the business in away that is consistent with the strategic goals of the Company. Eligibleparticipants generally will be high-performing, senior executives that havedirect impact on or responsibility for driving strategy throughout the Company,and will be selected by the Compensation Committee of the Board of Directors.

 

Incentivesunder the SBI Program are provided through grants of deferred stock unitspursuant to the Company’s 2001 Deferred Stock Unit Plan for SelectedEmployees.  Grants of deferred stock units are based on the value of thecash portion of the eligible participant’s fiscal year-end bonus target and amultiplier, which is then converted into a target number of deferred stockunits based upon the Company’s stock price as of the fiscal year-end prior togrant.  Participants may vest in between zero and 170% of the targetnumber of deferred stock units based on the extent to which financial andstrategic performance metrics are achieved over a three fiscal yearperiod.  The financial and strategic performance metrics are establishedat the beginning of each performance period.  For the fiscal 2004 through2007 performance period, the vesting criteria are based upon earnings per sharegrowth, market penetration and cross-selling ratios.

 

Participantsforfeit grants upon termination of employment for reasons other than death,disability or retirement; the Committee may authorize pro rata payouts in thecase of death, disability or retirement.  Upon a change of control, theCompensation Committee may make appropriate adjustments to the grants or mayaccelerate vesting or provide for a cash payment in lieu thereof.

 

## *Compensation Planfor Outside Directors*

 

In November 2001, theBoard of Directors approved the Compensation Plan for Outside Directors (the“Outside Director’s Plan”) which provides for the cash and stock compensationof outside Directors.  Under theDirector’s Plan, outside Directors areinitially paid in shares of the company’s common stock, or in a combination ofcash and shares, quarterly (at the completed quarter-end share price) forservices provided during the preceding quarter.  The total number of shares reserved forissuance under the Outside Director’s Plan is 50,000.  In August 2003, the Board of Directorsapproved amendments to the plan that included an increase in the compensationof the outside Directors and provided for an annual

 

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grantof company stock.  The company obtainedstockholder approval of amendments to the plan at our annual meeting inNovember 2003.  Compensation expenserecognized pursuant to this plan was $0.6 million, $0.6 million, and $0.2million in fiscal years 2005, 2004, and 2003 respectively.

 

*Dividends*

 

In May 2004, the Board ofDirectors of the company approved the initiation of a quarterly cash dividendin the amount of $0.075 per share.  Totalcash dividends paid in fiscal year 2005 were $9.8 million. The continuedpayment of cash dividends in the future is at the discretion of our Board ofDirectors and depends on numerous factors; including, without limitation, ournet earnings, financial condition, availability of capital, debt covenantlimitations and our other business needs, including those of our subsidiariesand affiliates.

 

*Initial Public Offering andCommon Stock*

 

In October 2000, wecompleted an initial public offering (“IPO”) of our Class A common stock. Inconjunction with this offering, each share of Watson Wyatt & Company’sredeemable common stock was converted into one share of Class B-1 common stockand one share of Class B-2 common stock of Watson Wyatt & Company Holdings.The Class B common stock was divided into two classes to accommodate differenttransfer restriction periods.  A total of9,956,140 Class B-1 and 12,745,015 Class B-2 shares were automaticallyconverted to Class A shares as the relevant 12- and 24- month transferrestrictions expired in October 2001 and 2002.

 

In conjunction with ourinitial public offering, we entered into agreements providing for additionaltransfer restrictions 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 with transfer restrictions became freely transferable in October2004.

 

In April 2004, thecompany completed a tender offer for shares of its Class Acommon stock, through which the company purchased 830,802 shares of its Class Ashares at a purchase price of $25.25 per share. The aggregate purchase price of the shares purchased through the tenderoffer was $21.0 million, excluding $0.7 million fees and expenses.

 

82

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**Note 11 - Goodwill and IntangibleAssets**

 

The changes in thecarrying amount of goodwill for the fiscal years ended June 30, 2004 and 2005, are as follows:

 
| ** **                           | ** ** | **Benefits  Group** | ** ** | **Technology  Solutions  Group** | ** ** | **Human  Capital  Group** | ** ** | **International** | ** ** | **Other** | ** ** | **Total** | ** ** |
|--------------------------------------|------------|---------------------|------------|----------------------------------|------------|---------------------------|------------|-------------------|------------|-----------|------------|-----------|------------|
|                                 |       |                |       |                             |       |                      |       |              |       |      |       |      |       |
| Balance as of  June 30, 2003         |       | $                   | 16,278     |                             | $          | 1,449                     |       | $                 | 69         |      | $          | 979       |       | $ | 1,214 |   | $ | 19,989 |   |
| Goodwill  recorded during the period |       | —              |       | —                           |       | —                    |       | 322               |       | —    |       | 322       |       |
| Translation  adjustment              |       | 53                  |       | —                           |       | 1                         |       | (9                | )          | —    |       | 45        |       |
| Balance as of  June 30, 2004         |       | $                   | 16,331     |                             | $          | 1,449                     |       | $                 | 70         |      | $          | 1,292     |       | $ | 1,214 |   | $ | 20,356 |   |
| Goodwill  recorded during the period |       | —              |       | —                           |       | —                    |       | 812               |       | —    |       | 812       |       |
| Translation  adjustment              |       | 459                 |       | —                           |       | 7                         |       | 254               |       | —    |       | 720       |       |
|                                 |       |                |       |                             |       |                      |       |              |       |      |       |      |       |
| Balance as of  June 30, 2005         |       | $                   | 16,790     |                             | $          | 1,449                     |       | $                 | 77         |      | $          | 2,358     |       | $ | 1,214 |   | $ | 21,888 |   |

 

The following tablereflects changes in the net carrying amount of the components of intangibleassets for the fiscal years ended June 30, 2004 and 2005:

 
| ** **                                    | ** ** | **Non-Contractual** | ** ** | ** **      | ** ** | ** **    | ** ** | ** **  | ** ** | ** ** | ** ** |
|-----------------------------------------------|------------|---------------------|------------|-----------------|------------|---------------|------------|-------------|------------|------------|------------|
| ** **                                    | ** ** | **Customer**        | ** ** | **Non-Compete** | ** ** | **Purchased** | ** ** | ** **  | ** ** | ** ** | ** ** |
| ** **                                    | ** ** | **Relationships**   | ** ** | **Agreements**  | ** ** | **Software**  | ** ** | **Pension** | ** ** | **Total**  | ** ** |
|                                          |       |                |       |            |       |          |       |        |       |       |       |
| Balance as of  June 30, 2003                  |       | $                   | 480        |            | $          | 269           |       | $           | 27         |       | $          | 113 |   | $ | 889 |   |
| Intangible  assets recorded during the period |       | —              |       | —          |       | —        |       | —      |       | —     |       |
| Amortization  expense                         |       | (198                | )          | (92             | )          | (25           | )          | —      |       | (315       | )          |
| Translation  adjustment                       |       | (29                 | )          | (1              | )          | —        |       | 11          |       | (19        | )          |
| Balance as of  June 30, 2004                  |       | $                   | 253        |            | $          | 176           |       | $           | 2          |       | $          | 124 |   | $ | 555 |   |
| Intangible  assets recorded during the period |       | —              |       | —          |       | —        |       | 486         |       | 486        |       |
| Amortization  expense                         |       | (217                | )          | (92             | )          | (2            | )          | —      |       | (311       | )          |
| Translation  adjustment                       |       | 48                  |       | —          |       | —        |       | (2          | )          | 46         |       |
| Balance as of  June 30, 2005                  |       | $                   | 84         |            | $          | 84            |       | $           | —     |       | $          | 608 |   | $ | 776 |   |

 

83

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The following tablereflects the carrying value of intangible assets at June 30, 2005 and 2004:

 
| ** **                                                    | ** ** | **Fiscal year 2005** | ** ** | **Fiscal year 2004** | ** ** |
|---------------------------------------------------------------|------------|----------------------|------------|----------------------|------------|
| ** **                                                    | ** ** | **Gross**            | ** ** | ** **           | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                                                    | ** ** | **Carrying**         | ** ** | **Accumulated**      | ** ** | **Carrying** | ** ** | **Accumulated** | ** ** |
| ** **                                                    | ** ** | **Amount**           | ** ** | **Amortization**     | ** ** | **Amount** | ** ** | **Amortization** | ** ** |
| Amortizable  intangible assets and intangible pension assets: |       |                 |       |                 |       |   |   |   |   |
| Non-contractual customer relationships                        |       | $                    | 1,001      |                 | $          | 917 |   | $ | 756 |   | $ | 503 |   |
| Non-compete agreements                                        |       | 672                  |       | 588                  |       | 672 |   | 496 |   |
| Purchased software                                            |       | 125                  |       | 125                  |       | 125 |   | 123 |   |
| Intangible pension asset                                      |       | 608                  |       | —               |       | 124 |   | — |   |
|                                                          |       |                 |       |                 |       |   |   |   |   |
| Total amortizable intangible assets                           |       | $                    | 2,406      |                 | $          | 1,630 |   | $ | 1,677 |   | $ | 1,122 |   |

 

The change in the grosscarrying amount of non-contractual customer relationships and a component ofthe intangible pension assets reflects translation adjustments.

 

The weighted averageremaining life of amortizable intangible assets at June 30, 2005, was 0.8years.  Future estimated amortizationexpense is as follows:

 

| **Fiscal year ending June 30** | ** ** | **Amount** | ** ** |
|--------------------------------|------------|------------|------------|
| 2006                           |       | 146        |       |
| 2007                           |       | 22         |       |
| 2008                           |       | —     |       |

 

**Note 12 - Income Taxes**

** **

Deferred income taxassets and liabilities reflect the effect of temporary differences between theassets and liabilities recognized for financial reporting purposes and theamounts recognized for income tax purposes. The company recognizes deferred tax assets if it is more likely than notthat a benefit will be realized.

 

The components of theincome tax provision for continuing operations include:

 
| ** **                       | ** ** | **Year Ended June 30** | ** ** |
|----------------------------------|------------|------------------------|------------|
| ** **                       | ** ** | **2005**               | ** ** | **2004** | ** ** | **2003** | ** ** |
|                             |       |                   |       |   |   |   |   |
| Current tax expense:             |       |                   |       |   |   |   |   |
| U.S.                             |       | $                      | 21,917     |   | $ | 30,696 |   | $ | 32,981 |   |
| State and local                  |       | 4,221                  |       | 7,975 |   | 8,015 |   |
| Foreign                          |       | 7,587                  |       | 4,051 |   | 6,670 |   |
|                             |       | 33,725                 |       | 42,722 |   | 47,666 |   |
| Deferred tax (benefit) expense:  |       |                   |       |   |   |   |   |
| U.S.                             |       | (1,151                 | )          | (8,636 | ) | (7,650 | ) |
| State and local                  |       | (156                   | )          | (2,453 | ) | (2,111 | ) |
| Foreign                          |       | (1,115                 | )          | (972 | ) | (2,890 | ) |
|                             |       | (2,422                 | )          | (10,117 | ) | (12,651 | ) |
| Total provision for income taxes |       | $                      | 31,303     |   | $ | 32,605 |   | $ | 35,015 |   |
|                                  |            |                        |            |  |  |  |  |  |  |  |  |

 

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Deferred income taxassets (liabilities) included in the Consolidated Balance Sheets at June 30,2005, and June 30, 2004, are comprised of the following:

 
| ** **                               | ** ** | **June 30** | ** ** |
|------------------------------------------|------------|-------------|------------|
| ** **                               | ** ** | **2005**    | ** ** | **2004** | ** ** |
|                                     |       |        |       |   |   |
| Depreciation and amortization            |       | $           | (11,575    | ) | $ | (2,789 | ) |
| Change in accounting method              |       | (80         | )          | — |   |
| Foreign temporary differences            |       | (361        | )          | (628 | ) |
| Other                                    |       | (1,518      | )          | (1,317 | ) |
| Gross deferred tax liabilities           |       | (13,534     | )          | (4,734 | ) |
|                                     |       |        |       |   |   |
| Accrued retirement benefits              |       | 83,955      |       | 41,742 |   |
| Deferred rent                            |       | 4,300       |       | 3,627 |   |
| Foreign temporary differences            |       | 10,231      |       | 7,568 |   |
| Foreign net operating loss carryforwards |       | 7,297       |       | 6,449 |   |
| Discontinued operations exit costs       |       | 715         |       | 1,226 |   |
| Other temporary differences              |       | 11,976      |       | 8,595 |   |
| Accrued compensation                     |       | 24,604      |       | 15,703 |   |
| Deferred revenue                         |       | 386         |       | 375 |   |
| Foreign Tax Credit Carryforwards         |       | 599         |       | — |   |
| Gross deferred tax assets                |       | 144,063     |       | 85,285 |   |
| Deferred tax assets valuation allowance  |       | (13,549     | )          | (10,887 | ) |
| Net deferred tax asset                   |       | $           | 116,980    |   | $ | 69,664 |   |

 

At June 30, 2005, we hadunused loss carryforwards for tax purposes in various jurisdictions outside theU.S. amounting to $23.2 million of which $9.2 million can be indefinitelycarried forward under local statutes. The remaining foreign loss carryforwards will expire, if unused, invarying amounts from 2006 through 2013. The valuation allowance includes the tax effect of foreign net operatingloss carryforwards of $7.3 million and the tax effect of certain foreigntemporary expenses of $6.2 million.

 

The net change in thevaluation allowance of $2.7 million in fiscal year 2005 and $3.7 million infiscal year 2004 is due primarily to the tax effect of the change in foreignnet operating losses and deferred foreign expenses.

 

Domestic and foreigncomponents of income from continuing operations before income taxes for each ofthe three years ended June 30 are as follows:

 
| ** ** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------|------------|----------|------------|----------|------------|----------|------------|
|       |       |     |       |     |       |     |       |
| Domestic   |       | $        | 69,003     |     | $          | 72,488   |       | $ | 76,686 |   |
| Foreign    |       | 13,696   |       | 10,056   |       | 8,709    |       |
|       |       |     |       |     |       |     |       |
|       |       | $        | 82,699     |     | $          | 82,544   |       | $ | 85,395 |   |
|            |            |          |            |          |            |          |            |  |  |  |  |

 

85

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The company has notprovided U.S. deferred taxes on cumulative earnings of foreign subsidiariesthat have been reinvested indefinitely. These earnings relate to ongoing operations and at June 30, 2005 wereapproximately $94 million.  Due to theavailability of U.S. foreign tax credits, it is not practicable to estimate theU.S. federal income tax liability that might be payable if such earnings were not reinvested indefinitely.  Deferred taxes have been provided forearnings of foreign subsidiaries which the company plans to remit.

 

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

 
| ** **                                                     | ** ** | **Year Ended June 30** | ** ** |
|----------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                     | ** ** | **2005**               | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                           |       |                   |       |   |   |   |   |
| Tax provision at U.S. federal statutory tax rate of 35 percent |       | $                      | 28,944     |   | $ | 28,890 |   | $ | 29,888 |   |
| Increase (reduction) resulting from:                           |       |                   |       |   |   |   |   |
| Foreign income subject to (lower) higher foreign tax rates     |       | (480                   | )          | (117 | ) | (541 | ) |
| Tax benefit of foreign losses reserved, net                    |       | 1,590                  |       | 1,146 |   | 1,272 |   |
| State income taxes, net of federal tax effect                  |       | 1,787                  |       | 3,152 |   | 3,416 |   |
| Non-deductible expenses                                        |       | (782                   | )          | 838 |   | 802 |   |
| Tax credits                                                    |       | (443                   | )          | (2,030 | ) | (409 | ) |
| Other                                                          |       | 687                    |       | 726 |   | 587 |   |
|                                                           |       |                   |       |   |   |   |   |
| Income tax provision                                           |       | $                      | 31,303     |   | $ | 32,605 |   | $ | 35,015 |   |

 

**Note 13 - Segment Information**

 

In North America, thecompany is primarily organized and managed by practice.  Although our consultants in our internationaloffices provide services in these same practice areas, our international operationsas a whole are managed geographically and comprise a single operatingsegment.  Therefore, we have fivereportable operating segments:

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

 

The company evaluates theperformance of its segments and allocates resources to them based on netoperating income on a pre-bonus, pre-tax basis.

 

86

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Thetable below presents specified information about reported segments as of andfor the year ended June 30, 2005:

 
| ** **                              | ** ** | ** **   | ** ** | **Technology** | ** ** | **Human**   | ** ** | ** **        | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------------------------|------------|--------------|------------|----------------|------------|-------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                              | ** ** | **Benefits** | ** ** | **Solutions**  | ** ** | **Capital** | ** ** | ** **        | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                              | ** ** | **Group**    | ** ** | **Group**      | ** ** | **Group**   | ** ** | **International** | ** ** | **Other**  | ** ** | **Total**  | ** ** |
| Revenue  (net of reimbursable expenses) |       | $            | 441,352    |           | $          | 66,340      |       | $                 | 56,456     |       | $          | 90,498     |       | $ | 42,719 |   | $ | 697,365 |   |
| Net operating income                    |       | 101,034      |       | 7,404          |       | 13,647      |       | 5,941             |       | 4,549      |       | 132,575    |       |
| Interest expense                        |       | 1,058        |       | 137            |       | 110         |       | 12                |       | 61         |       | 1,378      |       |
| Depreciation and amortization           |       | 8,799        |       | 1,777          |       | 967         |       | 2,681             |       | 2,573      |       | 16,797     |       |
| Receivables                             |       | 107,841      |       | 5,006          |       | 12,517      |       | 17,897            |       | 10,876     |       | 154,137    |       |
|                                         |            |              |            |                |            |             |            |                   |            |            |            |            |            |  |  |  |  |  |  |

 

Thetable below presents specified information about reported segments as of andfor the year ended June 30, 2004:

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

 

Thetable below presents specified information about reported segments as of andfor the year ended June 30, 2003:

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

 

87

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

 
| ** **                                                                                  | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                                                        |       |     |       |     |       |     |       |
| *Revenue:*                                                                                  |       |     |       |     |       |     |       |
| Total segment revenue                                                                       |       | $        | 697,365    |     | $          | 672,372  |       | $ | 672,677 |   |
| Reimbursable expenses not included in segment revenue                                       |       | 37,941   |       | 30,965   |       | 32,997   |       |
| Other, net                                                                                  |       | 2,115    |       | (1,332   | )          | 3,942    |       |
| Consolidated revenue                                                                        |       | $        | 737,421    |     | $          | 702,005  |       | $ | 709,616 |   |
|                                                                                        |       |     |       |     |       |     |       |
| *Net Operating Income:*                                                                     |       |     |       |     |       |     |       |
| Total segment income                                                                        |       | $        | 132,575    |     | $          | 108,628  |       | $ | 118,510 |   |
| Income from affiliates                                                                      |       | 7,146    |       | 7,109    |       | 5,787    |       |
| Differences in allocation methods for depreciation, G&A, pension  and medical costs (1) |       | 3,538    |       | 4,705    |       | (2,357   | )          |
| Other non-operating income                                                                  |       | (7,404   | )          | 6,222    |       | 761      |       |
| Discretionary bonuses                                                                       |       | (47,403  | )          | (38,870  | )          | (36,026  | )          |
| Other, net                                                                                  |       | (5,753   | )          | (5,250   | )          | (1,280   | )          |
|                                                                                        |       |     |       |     |       |     |       |
| Consolidated pretax income                                                                  |       | $        | 82,699     |     | $          | 82,544   |       | $ | 85,395 |   |
|                                                                                        |       |     |       |     |       |     |       |
| *Interest Expense:*                                                                         |       |     |       |     |       |     |       |
| Total segment expense                                                                       |       | $        | 1,378      |     | $          | 734      |       | $ | 748 |   |
| Differences in allocation method                                                            |       | (717     | )          | 159      |       | 54       |       |
| Consolidated interest expense                                                               |       | $        | 661        |     | $          | 893      |       | $ | 802 |   |
|                                                                                        |       |     |       |     |       |     |       |
| *Depreciation & Amortization:*                                                          |       |     |       |     |       |     |       |
| Total segment expense                                                                       |       | $        | 16,797     |     | $          | 18,062   |       | $ | 23,147 |   |
| Intangible asset amortization, not allocated to segments                                    |       | 311      |       | 315      |       | 416      |       |
| Differences in allocation method and other                                                  |       | 3,102    |       | 134      |       | (3,942   | )          |
| Consolidated depreciation and amortization expense                                          |       | $        | 20,210     |     | $          | 18,511   |       | $ | 19,621 |   |
|                                                                                        |       |     |       |     |       |     |       |
| *Receivables:*                                                                              |       |     |       |     |       |     |       |
| Total segment receivables                                                                   |       | $        | 153,116    |     | $          | 145,154  |       | $ | 129,349 |   |
| Net valuation differences (2)                                                               |       | 5,701    |       | 4,680    |       | 9,573    |       |
| Total billed and unbilled receivables                                                       |       | 158,817  |       | 149,834  |       | 138,922  |       |
| Assets not reported by segment                                                              |       | 459,862  |       | 362,334  |       | 375,540  |       |
| Consolidated assets                                                                         |       | $        | 618,679    |     | $          | 512,168  |       | $ | 514,462 |   |

 

----

(1) Depreciation, general and administrative, pension, and medicalcosts are allocated to our segments based on budgeted expenses determined atthe beginning 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 reflects the receivable balances used bymanagement to make business decisions, are included for management reportingpurposes net of deferred revenues – cash collections and invoices generated inexcess of revenue recognized in the segment revenues.

 

88

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

 
| ** **    | ** ** | **Revenue** | ** ** | **Long-lived Assets** | ** ** |
|---------------|------------|-------------|------------|-----------------------|------------|
| ** **    | ** ** | **2005**    | ** ** | **2004**              | ** ** | **2003** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|          |       |        |       |                  |       |   |   |   |   |   |   |   |   |
| United States |       | $           | 587,670    |                  | $          | 565,228 |   | $ | 580,428 |   | $ | 120,910 |   | $ | 90,385 |   | $ | 79,579 |   |
| Foreign       |       | 149,752     |       | 136,777               |       | 129,188 |   | 40,644 |   | 33,329 |   | 35,040 |   |
|          |       | $           | 737,421    |                  | $          | 702,005 |   | $ | 709,616 |   | $ | 161,554 |   | $ | 123,714 |   | $ | 114,619 |   |

 

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

 

**Note 14 - Commitments andContingent Liabilities**

 

The company historicallyhas provided guarantees on an infrequent basis to third parties in the ordinarycourse of business.  The guaranteesdescribed below are currently in effect and could require the company to makepayments to third parties under certain circumstances.

 

*Lettersof Credit*.  Thecompany has two outstanding letters of credit totaling $7.5 million under ourexisting credit facility to guarantee payment to beneficiaries in the eventthat the company fails to meet its financial obligations to thesebeneficiaries.  One letter of credit for$2.6 million will expire in October 2006, while the second letter of credit for$4.9 million will remain outstanding as long as we retain an ownership share ofour affiliated captive insurance company, PCIC. The estimated fair market value of these letters of credit is nominalbecause they have never been used, and the company believes that future usageis remote.

 

*Affiliate Agreements*.  In conjunction with our alliance with WWLLP,the company agreed to various indemnifications and guarantees, principallyregarding the performance of the company and its subsidiaries, some of whichbecame part of WWHE, as to such matters as leases, tax liabilities, liabilitiesfor prior acts or omissions arising from the operation of the UK and Europeanbusinesses prior to the alliance and failure to perform various obligationsunder the Alliance Agreements.  As ofJune 30, 2005, management believed that the possibility of any payments beingrequired under such indemnifications or guarantees was remote.  As a result of the business acquisitionbetween Watson Wyatt and Watson Wyatt LLP (Note 2), these indemnifications andguarantees will no longer represent a contingent liability of the company.

 

*IndemnificationAgreements*.  Thecompany has various agreements that provide that it may be obligated toindemnify the other party with respect to certain matters.  Generally, these indemnification clauses areincluded in contracts arising in the normal course of business and inconnection with the purchase and sale of certain businesses.  Although it is not possible to predict themaximum potential amount of future payments under these indemnification agreementsdue to the conditional nature of the company’s obligations and the unique factsof each particular agreement, the company does not believe that any potentialliability that might arise from such indemnity provisions is probable ormaterial.  There are no provisions forrecourse to third parties, nor are any assets held by any third parties thatany guarantor can liquidate to recover amounts paid under such indemnities.

 

*WellspringLeases*.  Wecontinue to guarantee three leases for office premises for WellspringResources, LLC (“Wellspring”), the benefitsadministration outsourcing business that we exited from in fiscal year1998.  At June 30, 2005, minimumremaining payments guaranteed under these leases, which expire at

 

89

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variousdates through 2007, total $11.6 million, excluding anticipated future subleaseincome.  See Note 16 for more informationregarding our obligation to guarantee Wellspring’s leases.

 

*LegalProceedings:* Fromtime to time, we are a party to various lawsuits, arbitrations or mediationsthat arise in the ordinary course of business. We have received subpoenas and requests for information in connectionwith government investigations.  The matters reported on below involve themost significant pending or potential claims against us.

 

We reserve for contingentliabilities based on Statement of Financial Accounting Standards No. 5,“Accounting for Contingencies” (SFAS 5) when it is determined that a liability,inclusive of defense costs, is probable and reasonably estimable.

 

*Government Investigations:*

 

*SECExamination of Investment Advisers.*  InDecember 2003, the Securities and Exchange Commission (SEC) formally askedmany of the major investment consulting firms, Watson Wyatt Investment Consulting(WWIC) among them, to provide detailed information on their business structuresand practices in order to determine if conflicts of interest with moneymanagers exist.  In May 2005, WWIC provided additional information toSEC staff in response to comments made in connection with its inquiry andamended its Form ADV to clarify the scope of its Advanced InvestmentSolutions service. This inquiry concluded with no adverse action being taken.

 

*Departmentof Justice Antitrust Investigation.*  InMarch 2004, the United States Department of Justice (DOJ) issued a CivilInvestigative Demand (CID) to Watson Wyatt and other companies in the employeebenefits industry.  On January 20, 2005, we received a supplementaryCID.  The DOJ sought to determine whether firms that have entered intoagreements with their clients limiting liability have done so in violation ofU.S. antitrust laws. Watson Wyatt provided information to DOJ in response tothe CIDs.   On June 24, 2005, DOJ enteredinto a Consent Decree with Professional Consultants Insurance Company, Inc.(PCIC), a captive malpractice insurance carrier that provides some of ourmalpractice coverage.  PCIC settledwithout admitting to any violation of antitrust laws.  No action has been brought against Watson Wyattor any of the PCIC members, and we continue to be a stockholder of and toobtain insurance from PCIC. The Consent Decree requires ratification by thecourt.

 

*New York State Attorney General.* On December 17, 2004, the New York State Attorney General issued asubpoena to Watson Wyatt seeking information about “override” and otherinsurance placement compensation.   Preliminary data indicate thatsuch payments accounted for less than 0.2 percent of Watson Wyatt’s revenueover the past four years.  Watson Wyatt has provided information to theNew York State Attorney General’s in response to the subpoena in January 2005.We have received no further inquiries from the New York State Attorney Generalsince responding.

 

*Professional Liability Claims:*

 

*Iron Workers Local 25 et al. v.Watson Wyatt & Co.*  On July 8, 2004,Watson Wyatt was served with an amended complaint filed by a former client inthe United States District Court for the Eastern District of Michigan. The complaint alleged malpractice, breach of contract, and related claims inthe performance of actuarial consulting.  The complaint stated that theplaintiff’s pension fund is underfunded as a result of the alleged deficienciesin our work.  In response to a discovery request, in January 2005 theplaintiffs disclosed that their minimum damage claim is $53.7 million.  Wehave established a loss and loss expense reserve in the amount of ourprofessional liability insurance self-retention for this case.

 

90

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*SBC Holdings, Inc.* On July 23, 2004, we received a demand letter from counsel for a clientalleging that errors in valuations for 2001 and subsequent years understatedthe liabilities of its pension plan and overstated its net worth.  As aresult, the client claimed it did not annuitize its defined benefit plan andredeemed its stock at an inflated price.  On April 15, 2005 we fileda declaratory action in the U.S. District Court for the Eastern District ofMichigan to compel arbitration of the matter.  On May 5, 2005, SBCfiled an answer and counterclaim to the declaratory judgment action, allegingdamages in excess of $46 million.  We have established a loss and lossexpense reserve in the amount of our professional liability insuranceself-retention for this case.

 

*ClientDemand Letter.*  On February 8, 2005, wereceived a demand letter from counsel for a client alleging failure to ensurethat the method for performing certain benefit calculations under the pensionadministration system developed by Watson Wyatt for the client was consistentwith the method required under the client’s pension equity plan and the summaryplan description, and failure to advise the client of the discrepancies betweenthe plan documents and the pension system.  The demand letter claimeddamages in excess of $13 million and also sought to hold the client’s outsideEmployee Retirement Income Security Act (ERISA) counsel responsible for thedamages.  On March 3, 2005, we entered into a tolling agreement withthe client and the client’s ERISA counsel in order to pursue resolution of thismatter through mediation. We have established a reserve in a non-materialamount for this case.

 

**Note 15 - Earnings Per Share**

** **

Basic earnings per shareis calculated on the basis of the weighted average numberof common shares outstanding during the year. Diluted earnings per share is calculated on the basis of the weightedaverage number of common shares outstanding plus the effect of outstandingstock options and employee stock purchase plan shares using the “treasurystock” method.  The components of basicand diluted earnings per share are as follows:

** **
| ** **                                                                         | ** ** | **Year Ended June 30** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                         | ** ** | **2005**               | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                               |       |                   |       |   |   |   |   |
| Income from  continuing operations                                                 |       | $                      | 51,396     |   | $ | 49,939 |   | $ | 50,380 |   |
| Income from  discontinued operations                                               |       | 766                    |       | 654 |   | 6,786 |   |
| Net income                                                                         |       | $                      | 52,162     |   | $ | 50,593 |   | $ | 57,166 |   |
|                                                                               |       |                   |       |   |   |   |   |
| Weighted average  outstanding shares of common stock                               |       | 32,541                 |       | 32,866 |   | 32,962 |   |
| Dilutive effect  of employee stock options and employee stock purchase plan shares |       | 304                    |       | 341 |   | 325 |   |
|                                                                               |       |                   |       |   |   |   |   |
| Common stock and  stock equivalents                                                |       | 32,845                 |       | 33,207 |   | 33,287 |   |
|                                                                               |       |                   |       |   |   |   |   |
| Basic earnings  per share                                                          |       |                   |       |   |   |   |   |
| Income from  continuing operations                                                 |       | $                      | 1.58       |   | $ | 1.52 |   | $ | 1.52 |   |
| Income from  discontinued operations                                               |       | 0.02                   |       | 0.02 |   | 0.21 |   |
| Basic earnings  per share, net income                                              |       | $                      | 1.60       |   | $ | 1.54 |   | $ | 1.73 |   |
|                                                                               |       |                   |       |   |   |   |   |
| Diluted earnings  per share                                                        |       |                   |       |   |   |   |   |
| Income from  continuing operations                                                 |       | $                      | 1.56       |   | $ | 1.50 |   | $ | 1.51 |   |
| Income from  discontinued operations                                               |       | 0.02                   |       | 0.02 |   | 0.21 |   |
| Diluted earnings  per share, net income                                            |       | $                      | 1.58       |   | $ | 1.52 |   | $ | 1.72 |   |

 

Therewere 1,920 outstanding stock options for the year ended June 30, 2005 that were not included in the diluted earnings per sharecalculation because their effect would have been antidilutive.

 

91

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**Note 16 - Discontinued Operations**

 

As discussed in Note 14,the company continues to guarantee three leases for office premises forWellspring.  In accordance with thecontractual arrangements pursuant to which Watson Wyatt divested its interestin Wellspring, Watson Wyatt agreed to share with State Street either costs orbenefits arising from these facilities leased by Wellspring.  Since one of the three Wellspring leases iscurrently sub-leased at rates in excess of the lease rate, the company iscontractually entitled to a share of the benefit of the excess cash flow fromthe sub-leases.During fiscal year 2005, the company received sublease income of approximately$44,000 in excess of lease payments related to this business.  Since the second quarter of fiscal year 2003,the leases have been generating positive cash flows of less than $100,000 perfiscal year. The company’s current assessment is that the positive cash flowfrom the sub-leases will continue until they expire in December 2006. The Company has no direct cash obligation toWellspring in the sense that its obligation is contingent upon the remainingspace being vacated.

 

During the third quarterof fiscal years 2003, 2004 and 2005, the company evaluated its accrual for theestimated remaining future obligations and costs related to the exit fromWellspring.  The evaluations included ananalysis of occupancy rates of Wellspring, along with an analysis of realestate market conditions in cities in which the leases exist and an assessmentof probable future sublease income for these leases.  As a result of the analysis performed duringfiscal years 2003, 2004 and 2005, the company reduced its accrual by $11.4million, $1.0 million and $1.25 million, respectively, less the associatedincome tax expenses.  Such adjustmentsare reflected in the Consolidated Statement of Operations for the third quarterof each fiscal year in the line “Adjustment to reduce estimated loss ondisposal of discontinued operations.” The remaining noncurrent liability of $1.75 million representsmanagement’s estimate of potential future cash outflows related to guaranteesassociated with Wellspring leases.

 

**Note 17 - Targeted Job Reductions**

 

We eliminatedapproximately 100 positions in our North American region during the firstquarter of fiscal year 2004.  A charge toearnings of $2.6 million related to these reductions was included in thecompany’s financial results for the quarter ended September 30, 2003.  We eliminated an additional 22 positions inour North American region during the second quarter of fiscal year 2004,resulting in a charge to earnings of $0.7 million in the company’s financialresults 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.

 

Also, we eliminatedapproximately 70 positions in our North American region during the secondquarter of fiscal year 2003.  A charge toearnings of $2.0 million related to these reductions was included in thecompany’s financial results for the quarter ended December 31, 2002.  Of the $2.0 million severance charge, $1.8million was included in salaries and employee benefit expenses and $0.2 millionwas included in professional and subcontracted services.

 

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

 

PCIC is a captive insurance company registeredin the state of Vermont owned by us and two other professional servicesfirms.  The member companies make equityinvestments to PCIC as necessary in order for PCIC to comply with capitalrequirements under Vermont law.

 

Annual premiums paid by the Company areexpensed ratably over the policy period of each fiscal year.  Prior to July 1, 2003, the first $5 millionof coverage had a premium structure which provided that the captive insurancecompany would recover from the firm defending the claim approximately 75% ofany loss up to $5 million.  Premiums wereestablished by PCIC based on expected losses. To the extent PCIC’s

 

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actual 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 retrospectively rated policy and recoversthrough its premium structure the amounts it expects to pay out for membercompanies in claims losses, continuing the loss sharing formula whereby 75% ofthe losses incurred by PCIC with respect to each member are incorporated in themember’s future premium charges, and will increase such member’s premium by approximatelya like amount over the next five years. On a quarterly basis, the Company evaluates, pursuant with its agreementwith PCIC and through inquiry with PCIC, if any liability should be accrued.  PCIC bases premium calculations, which aredetermined annually based on experience through March of each year, on relativerisk of the various lines of business performed by each of the owner companies,past claim experience of each owner company, growth of each of those companies,industry risk profiles in general and the overall insurance markets.

 

PCIC,in order to limit its consolidated risk, purchased an aggregate stop losspolicy 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, theBoard of Directors of PCIC, a captive insurance company of which we own 34.8percent, decided to pass on to each of its owners a credit in their 2003-04policy year in connection with benefits received from an aggregate stop lossinsurance policy entered into by PCIC.  PCIC’sBoard of Directors determined that this credit would be used to offset all or aportion of each insured’s obligation to PCIC for historical lossexperience.   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$5.6 million pre-tax non-operating gain in the first quarter of fiscal year2004 and included 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 million supplemental bonus accrual in thefirst quarter of fiscal year 2004 that is incremental to the Company’s fiscalyear end bonus, but was paid in September 2004 with the regular bonuscycle.  This supplemental bonus isincluded in Salaries and employee benefits.

 

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

 

In fiscal year 2002, wesold our U.S.-based public sector retirement business to Gabriel, Roeder, Smith& Company (“GRS”).  The futureconsideration from the sale of the U.S.-based public sector retirement businessis contingent upon the successful transition of certain clients to GRS and upontheir retention by GRS.

 

In accordance with the terms of the sale, GRS paid theCompany $0.5 million and $0.6 million of contingent payments in each of fiscalyears 2003 and 2004. The amount of additional contractual cash payments overthe upcoming fiscal year is also contingent upon the successful transition ofcertain clients to GRS and upon their retention by GRS.

 

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

 

Unaudited, summarizedfinancial data by quarter for the years ended June 30, 2005 and 2004, is as follows (in thousands, except per shareamounts): 

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

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

 

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**WATSONWYATT & COMPANY HOLDINGS**

**Schedule II**

**Valuationand Qualifying Accounts and Reserves**

(Thousands of U.S.Dollars)

 
| ** **                                   | ** ** | ** **            | ** ** | **Additions**       | ** ** | ** **         | ** ** | ** **     | ** ** | ** **     | ** ** |
|----------------------------------------------|------------|-----------------------|------------|---------------------|------------|--------------------|------------|----------------|------------|----------------|------------|
| ** **                                   | ** ** | ** **            | ** ** | **Charged Against** | ** ** | **Additions**      | ** ** | ** **     | ** ** | **Balance at** | ** ** |
| ** **                                   | ** ** | **Balance at**        | ** ** | **(Credited to)**   | ** ** | **Charged to**     | ** ** | ** **     | ** ** | **End of**     | ** ** |
| **Description**                              | ** ** | **Beginning of Year** | ** ** | **Revenue**         | ** ** | **Other Accounts** | ** ** | **Deductions** | ** ** | **Year**       | ** ** |
|                                         |       |                  |       |                |       |               |       |           |       |           |       |
| Year Ended June 30,  2005                    |
|                                         |       |                  |       |                |       |               |       |           |       |           |       |
| Allowance for  uncollectible accounts        |       | $                     | 1,241      |                | $          | 5,479              |       | $              | —     |           | $          | (4,606 | ) | $ | 2,114 |   |
|                                         |       |                  |       |                |       |               |       |           |       |           |       |
| Allowance for  unbillable accounts           |       | 456                   |       | (192                | )          | —             |       | —         |       | 264            |       |
|                                         |       |                  |       |                |       |               |       |           |       |           |       |
| Valuation allowance  for deferred tax assets |       | 10,887                |       | —              |       | 2,662              | (1)        | —         |       | 13,549         |       |
|                                         |       |                  |       |                |       |               |       |           |       |           |       |
| Year Ended June 30,  2004                    |
|                                         |       |                  |       |                |       |               |       |           |       |           |       |
| Allowance for  uncollectible accounts        |       | $                     | 862        |                | $          | 5,468              |       | $              | —     |           | $          | (5,089 | ) | $ | 1,241 |   |
|                                         |       |                  |       |                |       |               |       |           |       |           |       |
| Allowance for  unbillable accounts           |       | 419                   |       | 37                  |       | —             |       | —         |       | 456            |       |
|                                         |       |                  |       |                |       |               |       |           |       |           |       |
| Valuation allowance  for deferred tax assets |       | 7,211                 |       | —              |       | 3,676              | (1)        | —         |       | 10,887         |       |
|                                         |       |                  |       |                |       |               |       |           |       |           |       |
| Year Ended June 30,  2003                    |
|                                         |       |                  |       |                |       |               |       |           |       |           |       |
| Allowance for  uncollectible accounts        |       | $                     | 1,405      |                | $          | 7,871              |       | $              | —     |           | $          | (8,414 | ) | $ | 862 |   |
|                                         |       |                  |       |                |       |               |       |           |       |           |       |
| Allowance for  unbillable accounts           |       | 431                   |       | (12                 | )          | —             |       | —         |       | 419            |       |
|                                         |       |                  |       |                |       |               |       |           |       |           |       |
| Valuation allowance  for deferred tax assets |       | 5,463                 |       | —              |       | 1,748              | (1)        | —         |       | 7,211          |       |
|                                              |            |                       |            |                     |            |                    |            |                |            |                |            |  |  |  |  |  |  |

 

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(1)     The net increase is primarilydue to the tax effect of the change in realizable foreign net operating lossesand other foreign temporary differences.

 

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**ITEM 6.****EXHIBITS.**

 
| 3.1   |   | Amended and Restated  Certificate of Incorporation of Watson Wyatt & Company Holdings(1)                                                                                                                                                                                                                                                                                                                        |
|-------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.2   |   | Amended and Restated  Bylaws of Watson Wyatt & Company Holdings(2)                                                                                                                                                                                                                                                                                                                                              |
| 4     |   | Form of Certificate  Representing Common Stock(1)                                                                                                                                                                                                                                                                                                                                                                   |
| 10.1  |   | Credit Agreement Among  Suntrust Bank and Others dated July 11, 2005(12)                                                                                                                                                                                                                                                                                                                                            |
| 10.2  |   | Senior Officer Deferred  Compensation Plan(3)                                                                                                                                                                                                                                                                                                                                                                       |
| 10.3  |   | 2001 Deferred Stock  Unit Plan for Selected Employees(4)                                                                                                                                                                                                                                                                                                                                                            |
| 10.4  |   | Compensation Plan for  Outside Directors(5)                                                                                                                                                                                                                                                                                                                                                                         |
| 10.5  |   | Lease between Watson  Wyatt & Company and Arlington Office, L.L.C., dated April 27, 2004(6)                                                                                                                                                                                                                                                                                                                     |
| 10.6  |   | Watson  Wyatt & Company Performance Share Bonus Incentive Program(8)                                                                                                                                                                                                                                                                                                                                            |
| 10.7  |   | First  Amendment to Lease between Watson Wyatt & Company and Arlington Office,  L.L.C., dated April 22, 2005(9)                                                                                                                                                                                                                                                                                                 |
| 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 Watson Company Holdings Limited(10)                                                                                                                                                                                                |
| 10.9  |   | Form  of Employment Agreement between Watson Wyatt Limited and each of Chandrasekhar  Ramamurthy, Paul N. Thornton and Roger C. Urwin(10)                                                                                                                                                                                                                                                                           |
| 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(10)                                                                                                                                                                                                        |
| 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)  (10) |
| 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(11)                                                                                                                                                                                                                                                                 |
| 10.13 |   | Bonuses  Deed, dated as of April 15, 2005, by and among Watson Wyatt LLP, Watson Wyatt  Limited and Watson Wyatt & Company Holdings(10)                                                                                                                                                                                                                                                                         |
| 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(11)                                                                                                                                                                                                                                                                       |
| 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(10)                                                                                                                                                                                                   |
| 21    |   | Subsidiaries of Watson  Wyatt & Company Holdings(13)                                                                                                                                                                                                                                                                                                                                                            |
| 23    |   | Consent of Independent  Registered Public Accounting Firm                                                                                                                                                                                                                                                                                                                                                           |
| 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)                                                                                                                                                                                                                            |

 

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| (1)  |   | Incorporated  by reference from Registrant’s Form S-3/A, Amendment No. 1 (File No.  33-394973), filed on March 17, 2000 |
|------|--------|------------------------------------------------------------------------------------------------------------------------------|
| (2)  |   | Incorporated  by reference from Registrant’s Form 10-Q, filed on May 2, 2001                                            |
| (3)  |   | Incorporated  by reference from Registrant’s Form 10-K, filed on August 15, 2001                                        |
| (4)  |   | Incorporated  by reference from Registrant’s Form DEF14A, filed on October 5, 2001                                      |
| (5)  |   | Incorporated  by reference from Registrant’s Form DEF14A, filed on October 15, 2004                                     |
| (6)  |   | Incorporated  by reference from Registrant’s Form 10-Q, filed on May 7, 2004                                            |
| (7)  |   | Incorporated  by reference from Registrant’s Form 10-K, filed on August 17, 2004                                        |
| (8)  |   | Incorporated  by reference from Registrant’s Form 10-Q, filed on February 9, 2005                                       |
| (9)  |   | Incorporated  by reference from Registrant’s Form 10-Q, filed on May 10, 2005                                           |
| (10) |   | Incorporated  by reference from Registrant’s Form S-4 (File No. 33-3124629), filed on May  4, 2005                      |
| (11) |   | Incorporated  by reference from Registrant’s Form S-4/A, Amendment No. 1 (File No.  33-3124629) filed on June 13, 2005  |
| (12) |   | Incorporated  by reference from Registrant’s Form 8-K, filed on July 14, 2005                                           |
| (13) |   | Filed  with this Form 10-K                                                                                                   |

 

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