DEAR FELLOW STAKEHOLDER

Globalization is not a new theme at Watson Wyatt. In fact, our global strength has long been a source of competitive advantage. In the past year, however, globalization took on added meaning at Watson Wyatt. » In our client work, we saw a marked increase in global consulting assignments. And in our strategic direction, we made the historic decision to formally combine with our long-term alliance partner, Watson Wyatt LLP. » The time was right for the combination, and the opportunities are limitless. Our resources include 6,000 associates with diverse experiences working in 30 countries. Serving companies both locally and around the world, our revenues now total $1.2 billion. »

The combination is good news for our clients, our associates and our shareholders. Our clients will benefit from our enhanced worldwide resources. Our employees will enjoy the opportunities a larger, more diverse organization has to offer. And we will be even better equipped to compete in the global marketplace — both for business and for talent.

We finalized the combination on July 31, 2005, one month into our new fiscal year. But much of our focus throughout the year was on creating a truly integrated firm and strengthening our leadership position. That focus generated a palpable energy within Watson Wyatt, as we looked at the opportunities before us on the world stage. These range from winning new global actuarial appointments to leveraging our service lines far more aggressively throughout the world.

Ramping up our strategies to meet the new challenges made for an exciting and productive year. We not only broadened our global footprint but also achieved solid financial results, ending the year with positive momentum.

I’ll come back to the global theme, but first I’ll review our operating results for fiscal 2005.

FY05 Results
We saw our revenues increase 5 percent in fiscal year 2005, to $737.4 million. In short, our bottom-line results continued to grow, and several positive signs emerged on the revenue front. We ended the year with fourth-quarter revenues up a full 10 percent over the prior-year quarter.

We’re encouraged to see this growth, which was led by our Human Capital Group. The group’s revenue increased 26 percent over the previous year, as more companies reacted to labor market tightening and looked to Watson Wyatt to help them revise stock-based compensation plans. Our newly established government consulting practice contributed significantly to these results. The team won several major engagements with U.S. federal agencies, including the Department of Homeland Security and the Government Accountability Office.

In the Benefits Group — our largest segment, which includes consulting on health care and retirement programs — we grew revenues by 4 percent, to $441.4 million.

On the health care side, we increased revenues 12 percent, as we helped companies deal with ongoing cost pressures. Many organizations are experimenting with various new strategies in an effort to rein in costs. We champion and embrace new ideas, but we also focus intensely on verifiable results, which distinguishes our consulting approach. The market is responding very favorably to our “evidence-based” approach.

Our retirement consulting revenues grew by 2 percent for the year. Given the business climate surrounding pension issues, I believe these results are quite positive. In the United States, we gained nearly a percentage point in market share in our target market — a significant gain in a market that is characterized by high client persistency.

I’ll pause here to interject a note about the macro environment around pensions. We achieved the percentage point gain against difficult odds, as the demand for retirement consulting around the world has fallen. Given the concern about the financial risks faced by individual employees today, regulatory support for guaranteed pensions should be high. But that is not the case. Pension rules are overly cumbersome and can expose employers to significant funding volatility and legal risks. Too often, these factors can trump the business case for offering defined-benefit plans at some organizations. We believe that pensions are a valuable piece of the retirement mix — good for companies, employees and societies overall — so we’ll continue to urge lawmakers around the world to take action.

Regarding our other operating segments, we saw solid market demand for our technology solutions. Contrary to some media speculation, we have found in our consulting and research that the vast majority of companies are not looking to consolidate all of their HR administration with one vendor under total outsourcing arrangements. Instead, most are taking a more selective outsourcing approach, blending their own internal capabilities with the best offered by outside providers. In this marketplace, our technology solutions and consulting services are resonating very well.

We did make a change to our business model in the Technology Solutions Group: When we customize administrative systems for a client, we now recognize revenue related to the upfront work over the life of the contract, rather than at the outset. We recognize this revenue as the new systems go into service. As a result, our revenues for the Technology Solutions Group were $66.3 million, down 14 percent from the prior year — a difference we expect to make up as work on those projects progresses in the coming fiscal year.
Finally, our international segment revenues reached $90.5 million, up 9 percent over prior-year results, or 5 percent in local currencies. The strongest growth was in Greater China, Mexico and Brazil.

All in all, it was a year in which we made solid progress in line with our strategy, and took a momentous step to globalize — at a time when businesses on all continents are facing new labor market realities.

Today’s Global Marketplace
In recent years, I have worked with Watson Wyatt colleagues and the World Economic Forum to study the business impact of changing demographics. The facts are clear: Populations in mature economies are aging rapidly, and workforce growth in developing countries will dwarf that in mature economies in the coming decades. We’ll see new workers appear in emerging markets bringing higher-order skills. These developments will bring about a profound shift in economic activity across geographies. These trends raise many interesting business questions. For example, what are the most effective strategies for sourcing labor throughout the world? What governance and risk challenges come with these decisions?

Globalization creates unique challenges and opportunities for our clients. It also raises the bar in terms of how we respond. This is the fundamental reason behind our decision to combine with our long-term alliance partner. We are now better able to meet our clients’ global needs, with fully integrated resources and the ability to invest as a single firm.
And, of course, we now have new opportunities for growth across geographies and service lines. For example, our Insurance & Financial Services Group has a strong presence in Europe; it is now far easier for us to aggressively market those services in the Americas and Asia-Pacific. And, Continental Europe represents an attractive market for further expansion, including opportunities to leverage our highly regarded technology solutions.

Since Watson Wyatt & Company became a public company in 2000, we’ve pursued business combinations that meet three criteria: cultural fit, strategic fit and a very clear path to enhanced earnings. And we’ve always made the first one — cultural fit — our top priority. Watson Wyatt & Company and Watson Wyatt LLP have worked closely together for 10 years now. We have the same values — putting clients first, integrity and excellence in all we do — that are rooted in our histories. On one side, they go back nearly 60 years to the principles of B.E. Wyatt. On the other, even further — to Reuben Watson, who founded the world’s first actuarial consultancy in 1878. Corporate histories don’t get much richer than that.

Our unified firm has great traditions, great values and great people. As I said earlier, there is a renewed sense of energy at Watson Wyatt. We’re ready for new challenges, and we’re excited about the opportunities that lie ahead.

Sincerely,

John Haley

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