Towers Watson Delaware Holdings Inc. 10-Q 2006
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2006
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 001-16159
WATSON WYATT WORLDWIDE, INC.
(Exact name of registrant as specified in its charter)
(Registrants telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x Accelerated filer o Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.
WATSON WYATT WORLDWIDE, INC.
For the Three and Nine Months Ended March 31, 2006
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WATSON WYATT WORLDWIDE, INC.
The accompanying unaudited quarterly consolidated financial statements of Watson Wyatt Worldwide, Inc. and our subsidiaries (collectively referred to as we, Watson Wyatt, Watson Wyatt Worldwide or the company) are presented in accordance with the rules and regulations of the Securities and Exchange Commission (SEC) for quarterly reports on Form 10-Q. In the opinion of management, these consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, which are necessary for a fair presentation of the consolidated financial statements and results for the interim periods. The consolidated financial statements should be read together with the audited consolidated financial statements and notes thereto contained in the companys Annual Report on Form 10-K for the fiscal year ended June 30, 2005, which is filed with the SEC and may be accessed via EDGAR on the SECs web site at www.sec.gov. The year-end balance sheet data was derived from audited financial statements, but does not include all disclosures required by U.S. generally accepted accounting principles.
The results of operations for the nine months ended March 31, 2006 are not necessarily indicative of the results that can be expected for the entire fiscal year ending June 30, 2006. The results reflect certain estimates and assumptions made by management including estimated bonuses and anticipated tax liabilities that affect the amounts reported in the consolidated financial statements and related notes. Certain prior year amounts have been reclassified to conform to the current years presentation.
Note 2 Business Combination.
On July 31, 2005, the company acquired substantially all of the assets and assumed most liabilities of Watson Wyatt LLP (WWLLP) (the business combination), a leading United Kingdom-based actuarial, benefits and human resources consulting partnership. The company and WWLLP had jointly offered services since 1995 pursuant to alliance agreements and as a result, have business segments that are very similar in nature. See Note 3 for further information regarding the operating segments of the combined company.
The assets acquired from WWLLP are held by the companys principal U.K. subsidiary, Watson Wyatt Limited, thereby strengthening Watson Wyatts global market presence. The purchase price of $432.6 million consisted of £88.3 million in cash, or $156.1 million at the exchange rate in effect at August 1, 2005, the issuance of 9,090,571 shares of the companys common stock valued at $238.7 million, transaction costs of $14.6 million and additional consideration including debt forgiveness and investment elimination. The shares paid were valued at $26.26 per share, which was the average of the closing market prices of the companys stock over five business days beginning with two business days prior to the announcement date of January 18, 2005 and ending with the two business days following the announcement date. In addition, a further 1,950,000 shares may be paid to WWLLP as additional consideration after June 30, 2007, contingent upon the achievement by the acquired business of certain agreed-upon financial performance goals. Watson Wyatt Limiteds results of operations are included in the consolidated financial statements beginning August 1, 2005.
Accounting and Goodwill Allocation
The business combination has been accounted for using the purchase method of accounting as prescribed in Statement of Financial Accounting Standards No. 141, Business Combinations (SFAS 141), where the assets acquired and liabilities assumed are recorded at their respective fair values as of the combination date. As of the business combination date, the company determined the following estimated fair values for the proportionate assets purchased and liabilities assumed. The determination of estimated fair value requires management to make significant estimates and assumptions. The company hired an independent third party to assist in the valuation of assets. Although the company does not anticipate any significant adjustments, to the extent that the estimates used need to be refined, the company will do so upon making that determination but not later than one year from the business combination date.
The preliminary allocation of the purchase price resulted in the allocation of $281.9 million to goodwill, which has been assigned to our segments as follows:
The majority of the goodwill will be deductible in the U.K. over a period not exceeding 25 years.
During the third quarter of fiscal year 2005, the company entered into a foreign currency forward contract to offset the risk associated with the foreign exchange (British Pound) exposure inherent in the combination. The forward contract provided for the purchase of £88 million at a fixed price of $164.5 million, with a settlement date of July 29, 2005. In accordance with Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133), as amended and interpreted, since the forward contract was associated with a business combination that is subject to the provisions of SFAS 141 and the combination involved an equity method investment, the forward contract did not qualify for hedge accounting. As a result, changes in fair value associated with the forward contract were required to be recognized in the Consolidated Statements of Operations. Consequently, a loss of $3.6 million was recognized during the first quarter of fiscal year 2006 and included in other non-operating income. Losses recognized under this forward contract since inception of the contract totaled $8.4 million.
Pro Forma Financial Information
The following unaudited pro forma combined statements of operations have been provided to present illustrative combined unaudited statements of operations for the three and nine month periods ended March 31, 2006 and 2005, giving effect to the business combination as if it had been completed on July 1, 2005 and 2004, respectively. The unaudited historical combined statement of operations for the three month period ended March 31, 2006 reflects the actual financial results of the combined company. The three month period ended March 31, 2005 combines the historical financial results of Watson Wyatt for the three months ended March 31, 2005 with the pro forma historical financial results from WWLLP for the three months ended March 31, 2005. The nine month period ended March 31, 2006 includes historical financial results from July 2005 of Watson Wyatt, pro forma results of WWLLP for the month of July 2005, combined with the results of the consolidated entity from August 1, 2005 through March 31, 2006. The nine month period ended March 31, 2005 combines the historical financial results of Watson Wyatt for the nine months ended March 31, 2005 with the pro forma historical financial results from WWLLP for the nine months ended March 31, 2005.
The unaudited pro forma combined financial information shows the impact of the business combination on Watson Wyatts historical results of operations. The unaudited pro forma combined income statements are presented for illustrative purposes only and are not indicative of the results of operations that might have occurred had the business combination actually taken place as of the dates specified, or that may be expected to occur in the future. They do not assume any benefits from any cost savings or synergies and do not reflect any integration costs that the combined company realized or incurred after the combination.
Pro-Forma Combined Statements of Operations
(in thousands, except per share data)
Note 3 Segment Information.
In North America and Europe, the company is primarily organized and managed by practice. Although our consultants in our Asia-Pacific and Latin America offices provide services in these same practice areas, their operations as a whole are managed geographically and comprise a single operating segment. As a result, we have six reportable operating segments or practice areas as follows:
(1) Benefits Group
(2) Technology and Administration Solutions Group
(3) Human Capital Group
(4) Insurance & Financial Services Group
(5) Investment Consulting Group
(6) International Comprising Asia Pacific and Latin America
Management evaluates the performance of its segments and allocates resources to them based on net operating income on a pre-bonus, pre-tax basis. The category previously reported as other has been reclassified as All other segments in the reconciliation of reportable segments to consolidated amounts as prescribed in Statement of Financial Accounting Standards No. 131 Disclosures about Segments of an Enterprise and Related Information, (SFAS 131). This includes communication and change management implementation support services. Prior period amounts have been restated to conform to the current classification.
The table below presents specified information about reported segments as of and for the three months ended March 31, 2006. As a result, it includes the consolidated results from the acquired businesses, as now held by Watson Wyatt Limited:
The table below presents specified information about reported segments as of and for the three months ended March 31, 2005. As a result, it does not include results from Watson Wyatt Limited since the combination was not completed until July 31, 2005:
The table below presents specified information about reported segments as of and for the nine months ended March 31, 2006. As a result, it includes the consolidated results from Watson Wyatt Limited since August 1, 2005. Net operating income presented below has been adjusted to correct amounts that were inadvertently misstated primarily in the Technology and Administration Solutions Group for the quarter ended September 30, 2005, improving margins in the Technology and Administration Solutions Group from what was previously reported.
The table below presents specified information about reported segments as of and for the nine months ended March 31, 2005. As a result, it does not include results from Watson Wyatt Limited since the combination was not completed until July 31, 2005:
Information about interest income and tax expense is not presented as a segment expense because such items are not considered a responsibility of the segments operating management. Prior year data has been reclassified to be consistent with current segments for comparative purposes.
Reconciliations of the information reported by segment to the historical consolidated amounts follow for the three and nine month periods ended March 31, 2006 and 2005:
(1) Depreciation, general and administrative, pension, and medical costs are allocated to our segments based on budgeted expenses determined at the beginning of the fiscal year as management believes that these costs are largely uncontrollable to the segment. To the extent that the actual expense base upon which allocations are made differs from the forecast/budget amount, a reconciling item will be created between internally allocated expenses and the actual expense that we report for GAAP purposes.
(2) Total segment receivables, which reflects the receivable balances used by management to make business decisions, are included for management reporting purposes net of deferred revenues cash collections and invoices generated in excess of revenue recognized in the segment revenues and cash held in suspense.
(3) Assets not reported by segment for management reporting purposes include goodwill and intangible assets of $484.1 million.
Note 4 Share-based Compensation.
The Financial Accounting Standards Board (FASB) issued SFAS123(R), Share-based Payment as a revision to Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation. SFAS 123(R) requires companies to account for share-based payment transactions with employees using a fair-value based method, thereby eliminating the disclosure-only provisions of SFAS 123. SFAS 123(R) became effective for the company as of July 1, 2005.
The company has four share-based compensation plans, which are described below. These compensation plans include the 2001 Employee Stock Purchase Plan, the 2001 Deferred Stock Unit Plan for Selected Employees, the Amended Compensation Plan for Outside Directors and the 2000 Long-Term Incentive Plan. All four plans have been approved by stockholders.
2001 Employee Stock Purchase Plan
The employee stock purchase plan enables employees to purchase shares of the companys stock. No compensation expense was recognized through the third quarter of fiscal year 2006 as a result of this plan. Pro forma compensation expense of $1.0 million was disclosed for the nine months ended March 31, 2005.
The 2001 Deferred Stock Unit Plan for Selected Employees is intended to provide selected associates of the company with additional incentives by permitting the company to grant them an equity interest in the company in the form of restricted stock units, in lieu of a portion of their annual fiscal year end bonus. Shares under this plan are awarded during the first quarter of each fiscal year. During the first quarter of fiscal year 2006, 177,300 shares of common stock, at a market price of $26.94 were awarded for a total fair value of $4.8 million. During the first quarter of fiscal year 2005, 151,610 shares of common stock, at a market price of $26.68 were awarded, for a total fair value of $4.0 million. In addition, under the 2001 Deferred Stock Unit Plan for Selected Employees, the company also awarded approximately 4,000 shares, at a market price per share of $30.05 for a total fair value of approximately $0.2 million, during the third quarter of fiscal year 2006 in connection with the Chairmans Award Program. The Chairmans Award Program recognizes certain employees who have made outstanding contributions to strategy execution.
On November 19, 2004, the companys Board of Directors approved a long-term bonus arrangement pursuant to the companys 2001 Deferred Stock Unit Plan for Selected Employees. The arrangement, called the Performance Share Bonus Incentive Program (the SBI Program), is a long-term stock bonus arrangement for senior executives of the company and its affiliates that is designed to strengthen incentives and align behaviors to grow the business in a way that is consistent with the strategic goals of the company.
Incentives under the SBI Program are provided through grants of deferred stock units pursuant to the companys 2001 Deferred Stock Unit Plan for Selected Employees. Grants of deferred stock units are based on the value of the cash portion of the eligible participants fiscal year-end bonus target and a multiplier, which is then converted into a target number of deferred stock units based upon the companys stock price as of the fiscal year-end prior to grant. Participants may vest between zero and 170% of the target number of deferred stock units based on the extent to which financial and strategic performance metrics are achieved over a three fiscal year period. The financial and strategic performance metrics are established at the beginning of each performance period. For the fiscal 2004 through 2007 performance period, the vesting criteria are based upon earnings per share growth, market penetration and cross-selling ratios.
No compensation expense was recorded pursuant to this plan through the first nine months of fiscal year 2006. Expenses for this plan will be recognized when awards are both probable and reasonably estimable and compensation expense will be recognized as a component of the discretionary annual bonus recorded in salaries and employee benefits.
The Amended Compensation Plan for Outside Directors (the Outside Directors Plan) provides for cash and stock compensation of outside Directors. Under the Outside Directors Plan, outside Directors are initially paid in shares of the companys common stock, or in a combination of cash and shares, quarterly for services provided during the preceding quarter. Approximately $0.3 million of compensation expense was recorded relative to this plan during the first nine months of fiscal year 2006 compared to $0.2 million in the first nine months of fiscal year 2005.
The company issued non-qualified stock options under the 2000 Long-Term Incentive Plan (the Stock Option Plan) in conjunction with its initial public offering in fiscal year 2001. No options have been granted under the stock option plan since fiscal year 2001 and the company does not currently intend to issue further stock options under the Stock Option Plan. For the first nine months of fiscal year 2006, the company recognized $0.3 million in compensation expense related to the Stock Option Plan, in accordance with SFAS 123(R). For the first nine months of fiscal year 2005, the company disclosed pro forma compensation cost of $0.7 million, related to the Stock Option Plan.
Note 5 Retirement Benefits.
Defined Benefit Plans
We sponsor both qualified and non-qualified, non-contributory defined benefit pension plans covering substantially all of our associates. Under our plans in North America and Hong Kong, benefits are based on the number of years of service and the associates compensation during the five highest paid consecutive years of service (subject to grandfathering provisions under which benefits would be determined based on the three highest paid consecutive years of service). The non-qualified plan, which exists only in North America, provides for pension benefits that would be covered under the qualified plan but are limited by the Internal Revenue Code. The non-qualified plan has no assets and therefore is an unfunded arrangement. The benefit liability is reflected on the balance sheet. The measurement date for the plans is June 30.
As a result of the business combination described in Note 2, we have included the defined benefit pension plan disclosures for our recently acquired U.K. operations. The disclosures for this plan, together with our historical U.K. plan (collectively the U.K. Plans), are shown separately from the North America and Hong Kong plans because the related amounts, including obligations, assets and net periodic benefit costs, are significant, and the assumptions used are significantly different, than all other plans sponsored by the company. Benefits under the U.K. plans are based on the number of years of service and the associates compensation during the three years before leaving the plan. The measurement date for the defined benefit plan for the recently combined U.K. operations is July 31 whereas the measurement date for the historical U.K. plan is June 30.
Components of Net Periodic Benefit Cost for Defined Benefit Pension Plans
The following table sets forth the components of net periodic benefit cost for the companys defined benefit pension plan for North America and Hong Kong for the three and nine month periods ended March 31, 2006 and 2005, and for the U.K. plans for the three and nine months ended March 31, 2006:
(1) Reflects the net periodic benefit cost for (1) the defined benefit pension plan for our recently combined U.K. operations for the eight month period ending March 31, 2006 and (2) the historical U.K. plan for the nine months ended March 31, 2006.
The fiscal year 2006 net periodic benefit cost is based, in part, on the following rate assumptions as of June 30, 2005 for the North America and Hong Kong plans and July 31, 2005 for the U.K. plans:
The discount rate applicable to the various plans varies in accordance with the interest rate environment in the respective host country. The expected long-term rate of return on assets attributable to the various plans is based on the allocation of assets within each specific plan. Assets in the North America and Hong Kong plans are heavily weighted in equities, which are expected to generate a higher return than bonds, which constitute the majority of investments for the UK plans.
The company made $0.8 million in contributions to the non-U.S. plans during the third quarter of fiscal year 2006 and no contributions to the U.S. plans in the third quarter. We anticipate making $0.8 million in contributions to the non-U.S. plans in the last quarter of fiscal year 2006. We do not anticipate making additional contributions to the U.S. plan for the remainder of fiscal year 2006.
The company made $2.2 million in contributions to the U.K. plans during the third quarter of fiscal year 2006 and anticipates making $4.8 million in contributions over the remainder of fiscal year 2006.
Defined Contribution Plans
In the U.S., we sponsor a savings plan that provides benefits to substantially all U.S. associates with a match to employee contributions at a rate of 50 percent of the first 6 percent up to $60,000 of associates eligible compensation. The company may also make an annual profit sharing contribution to the plan in an amount that is dependant upon the companys financial performance during the fiscal year.
In the U.K., we sponsor a savings plan that provides benefits to substantially all U.K. associates. The company provides a basic contribution and a match to employee contributions, both of which depend on age. The maximum employer contribution is 10% up to £91,000 of associates eligible compensation.
Health Care Benefits
In the U.S., we sponsor a contributory health care plan that provides hospitalization, medical and dental benefits to substantially all U.S. associates. We accrue a liability for estimated incurred but unreported claims based on projected use of the plan as well as prior plan history.
In the U.K., we sponsor a non-contributory medical insurance plan that provides hospitalization and medical benefits and a contributory dental plan that provides dental benefits to substantially all U.K. associates.
We provide certain health care and life insurance benefits for retired associates. The principal plans cover associates in the U.S. and Canada who have met certain eligibility requirements. Our principal post-retirement benefit plans are unfunded. We accrue a liability for these benefits in accordance with Statement of Financial Accounting Standards No. 106, Employers Accounting for Postretirement Benefits Other Than Pensions. We do not have postretirement benefit plans in the U.K. and Hong Kong.
Components of Net Periodic Benefit Cost for Other Postretirement Plans
The following table sets forth the components of net periodic benefit cost for the companys healthcare and post-retirement plans for the three and nine months ended March 31, 2006 and 2005:
The company made contributions in the form of premiums and medical claim payments to its healthcare and post-retirement plans of $0.9 million in the three months ended March 31, 2006 and 2005, and contributions of $2.5 million and $2.1 million in the nine months ended March 31, 2006 and 2005, respectively. We plan to make additional payments estimated to total $0.8 million through June 30, 2006.
Note 6 Goodwill & Intangible Assets.
The increases in goodwill and intangible assets outlined below for the nine months ended March 31, 2006 are principally attributable to the business combination during the first quarter. See Note 2 for further details regarding the business combination. The company performs its impairment tests in the fourth quarter of the companys fiscal year, based on closing balances in the third quarter.