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**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

**Quarterly Report Pursuant to Section 13or 15(d) of the Securities Exchange Act of 1934**

 

**For thequarterly period ended March 31, 2009**

 

**Commissionfile number: 001-33928**

 

**RiskMetrics Group, Inc.**

(Exact name of registrant asspecified in its charter)

 

| **Delaware**                                                           | ** ** | **20-8175809**                     |
|------------------------------------------------------------------------|------------|------------------------------------|
| (State or other jurisdiction of  incorporation or organization)        |       | (IRS Employer  Identification No.) |
| ** **                                                             | ** ** | ** **                         |
| **One Chase Manhattan Plaza, 44****th Floor  New York, New York** | ** ** | **10005**                          |
| (Address of principal executive offices)                               |       | (Zip Code)                         |

 

**(212) 981-7475**

(Registrant’s telephonenumber, including area code)

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorterperiod that the registrant was required to file such reports) and (2) hasbeen subject to such filing requirements for the past 90 days.Yes  x No o

 

Indicate by check mark whether the registrant has submittedelectronically and posted on its corporate Web site, if any, every InteractiveData File required to be submitted and posted pursuant to Rule 405 ofRegulation S-T (§ 232.405 of this chapter) during the preceding 12 months (orfor such shorter period that the registrant was required to submit and postsuch files). Yes  oNo o

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, a non-accelerated filer, or a smaller reportingcompany. See definitions of “large accelerated filer,” “accelerated filer,” and“smaller reporting company” in Rule 12b-2 of the Exchange Act. (Checkone):

 

| Large accelerated filer o                |   | Accelerated filer x         |
|-----------------------------------------------|--------|----------------------------------|
|                                          |   |                             |
| Non-accelerated filer o                  |   | Smaller reporting company o |
| (Do not check if a smaller reporting company) |   |                             |

 

Indicate by check mark whether the Registrant is a shell company (asdefined in rule 12b-2 of the Act). Yes o No x

 

The number of shares outstanding of each of the registrant’s classes ofcommon stock, as of April 30, 2009 was:

 
| **Class**                    | ** ** | **Outstanding** |
|------------------------------|------------|-----------------|
| Common stock  $.01 par value |       | 61,638,440      |

 

 

 

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**RiskMetricsGroup, Inc**

**Indexto Form 10-Q**

 

**Tableof Contents**

 
| ** **                                                                                                      | ** **                                                                                                                                                                  | **Page Number** |
|-----------------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------------------|
| **PART I — FINANCIAL INFORMATION**                                                                    |
| Item 1— Financial Statements                                                                          | ** **                                                                                                                                                                  |
|                                                                                                            | Condensed Consolidated Financial Statements as of March 31, 2009  and December 31, 2008 and for the three months ended March 31, 2009  and 2008 (unaudited): |                 |
|                                                                                                            | Condensed Consolidated Balance Sheets                                                                                                                                       |                 |
|                                                                                                            | Condensed Consolidated Statements of  Operations                                                                                                                            |                 |
|                                                                                                            | Condensed Consolidated Statements of  Changes in Stockholders’ Equity                                                                                                  |                 |
|                                                                                                            | Condensed Consolidated Statements of Cash  Flows                                                                                                                            |                 |
|                                                                                                            | Notes to  Condensed Consolidated Financial Statements                                                                                                                       |                 |
| Item 2 —  Management’s Discussion and Analysis of Financial Condition and Results of  Operations |                                                                                                                                                                        |
| Item 3 —  Quantitative and Qualitative Disclosures About Market Risk                                  |                                                                                                                                                                        |
| Item 4 —  Controls and Procedures                                                                     |                                                                                                                                                                        |
|                                                                                                            |
| **PART II — OTHER INFORMATION**                                                                       |
| Item 1 — Legal Proceedings                                                                            |                                                                                                                                                                        |
| Item1A—Risk Factors                                                                                        |                                                                                                                                                                        |
| Item 2 —  Unregistered Sales of Equity Securities and Use of Proceeds                                 |                                                                                                                                                                        |
| Item 3 —  Defaults Upon Senior Securities                                                             |                                                                                                                                                                        |
| Item 4 —  Submission of Matters to a Vote of Security Holders                                         |                                                                                                                                                                        |
| Item 5 — Other Information                                                                            |                                                                                                                                                                        |
| Item 4 — Exhibits                                                                                     |                                                                                                                                                                        |
|                                                                                                                 |                                                                                                                                                                             |                      |  |

 

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**RISKMETRICSGROUP, INC.**

 

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(UNAUDITED)**

**(Inthousands, except share amounts)**

 
| ** **                                                                                                                                                                                             | ** ** | **March 31,  2009** | ** ** | **December 31,  2008** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                                                                                             | ** ** | ** **               | ** ** | ** **                  | ** ** |
| CURRENT ASSETS:                                                                                                                                                                                        |       |                     |       |                        |       |
| Cash and cash equivalents                                                                                                                                                                              |       | $                        | 159,328    |                        | $          | 170,799 |   |
| Accounts receivable, net                                                                                                                                                                               |       | 52,179                   |       | 42,319                      |       |
| Deferred tax assets                                                                                                                                                                                    |       | 2,441                    |       | 2,092                       |       |
| Income taxes receivable                                                                                                                                                                                |       | —                   |       | 4,562                       |       |
| Other receivables and prepaid expenses                                                                                                                                                                 |       | 7,325                    |       | 5,666                       |       |
| Total current assets                                                                                                                                                                                   |       | 221,273                  |       | 225,438                     |       |
| Intangibles—net                                                                                                                                                                                   |       | 148,848                  |       | 148,340                     |       |
| Goodwill                                                                                                                                                                                               |       | 318,659                  |       | 308,613                     |       |
| Property and equipment—net                                                                                                                                                                        |       | 14,450                   |       | 15,400                      |       |
| Deferred financing costs                                                                                                                                                                               |       | 4,968                    |       | 5,227                       |       |
| Other assets                                                                                                                                                                                           |       | 2,725                    |       | 1,995                       |       |
| TOTAL ASSETS                                                                                                                                                                                           |       | $                        | 710,923    |                        | $          | 705,013 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                          |       |                     |       |                        |       |
| CURRENT LIABILITIES:                                                                                                                                                                                   |       |                     |       |                        |       |
| Trade accounts payable                                                                                                                                                                                 |       | $                        | 4,821      |                        | $          | 1,981 |   |
| Accrued expenses                                                                                                                                                                                       |       | 20,546                   |       | 40,174                      |       |
| Income taxes payable                                                                                                                                                                                   |       | 1,569                    |       | —                      |       |
| Debt, current portion                                                                                                                                                                                  |       | 2,965                    |       | 2,224                       |       |
| Deferred revenue, current portion                                                                                                                                                                      |       | 120,862                  |       | 109,525                     |       |
| Other current liabilities                                                                                                                                                                              |       | 211                      |       | 211                         |       |
| Total current liabilities                                                                                                                                                                              |       | 150,974                  |       | 154,115                     |       |
| LONG-TERM LIABILITIES                                                                                                                                                                                  |       |                     |       |                        |       |
| Debt                                                                                                                                                                                                   |       | 287,654                  |       | 288,395                     |       |
| Deferred tax liabilities                                                                                                                                                                               |       | 31,125                   |       | 31,405                      |       |
| Deferred revenue                                                                                                                                                                                       |       | 1,336                    |       | 1,364                       |       |
| Other long-term liabilities                                                                                                                                                                            |       | 25,011                   |       | 26,567                      |       |
| Total liabilities                                                                                                                                                                                      |       | $                        | 496,100    |                        | $          | 501,846 |   |
|                                                                                                                                                                                                   |       |                     |       |                        |       |
| COMMITMENTS AND CONTINGENCIES                                                                                                                                                                          |       |                     |       |                        |       |
|                                                                                                                                                                                                   |       |                     |       |                        |       |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                                             |       |                     |       |                        |       |
| Common stock, $.01 par value—200,000,000  authorized; 61,774,324 and 61,673,960 issued and 61,531,170 and 61,430,806  outstanding at March 31, 2009 and December 31, 2008, respectively |       | $                        | 618        |                        | $          | 617 |   |
| Treasury stock—243,154 shares                                                                                                                                                                     |       | (579                     | )          | (579                        | )          |
| Additional paid-in capital                                                                                                                                                                             |       | 434,101                  |       | 431,781                     |       |
| Accumulated other comprehensive loss                                                                                                                                                                   |       | (16,447                  | )          | (17,255                     | )          |
| Accumulated deficit                                                                                                                                                                                    |       | (202,870                 | )          | (211,397                    | )          |
| Total stockholders’ equity                                                                                                                                                                        |       | 214,823                  |       | 203,167                     |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                        |       | $                        | 710,923    |                        | $          | 705,013 |   |

 

See notes tocondensed consolidated financial statements.

 

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**RISKMETRICSGROUP, INC.**

 

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**FORTHE THREE MONTHS ENDED MARCH 31, 2009 AND 2008**

 

**(UNAUDITED)**

 

**(Inthousands, except share and per share amounts)**

 
| ** **                                                             | ** ** | **2009**   | ** ** | **2008**   | ** ** |
|------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| REVENUES                                                               |       | $          | 77,381     |       | $          | 71,220 |   |
| OPERATING COSTS AND EXPENSES:                                          |       |       |       |       |       |
| Cost of revenues                                                       |       | 23,322     |       | 22,704     |       |
| Research and development                                               |       | 10,137     |       | 10,461     |       |
| Selling and marketing                                                  |       | 7,067      |       | 9,206      |       |
| General and administrative                                             |       | 10,607     |       | 9,205      |       |
| Depreciation and amortization of property  and equipment               |       | 1,955      |       | 2,115      |       |
| Amortization of intangible assets                                      |       | 5,592      |       | 5,456      |       |
| Loss on disposal of fixed assets                                       |       | —     |       | 22         |       |
| Total operating costs and expenses (1)                                 |       | 58,680     |       | 59,169     |       |
| INCOME FROM OPERATIONS                                                 |       | 18,701     |       | 12,051     |       |
|                                                                   |       |       |       |       |       |
| INTEREST, DIVIDEND, INVESTMENT, AND OTHER  INCOME (EXPENSE), NET:      |       |       |       |       |       |
|                                                                   |       |       |       |       |       |
| Interest, dividend and investment income                               |       | 193        |       | 299        |       |
| Interest expense (Note 7)                                              |       | (5,386     | )          | (9,163     | )          |
| Other expenses (Notes 7 & 8)                                  |       | —     |       | (2,613     | )          |
| Total interest, dividend, investment, and  other income (expense), net |       | (5,193     | )          | (11,477    | )          |
| INCOME BEFORE PROVISION FOR INCOME TAXES                               |       | 13,508     |       | 574        |       |
| PROVISION FOR INCOME TAXES                                             |       | 4,981      |       | 227        |       |
| NET INCOME                                                             |       | $          | 8,527      |       | $          | 347 |   |
|                                                                   |       |       |       |       |       |
| NET INCOME PER SHARE:                                                  |       |       |       |       |       |
| Basic                                                                  |       | $          | 0.14       |       | $          | 0.01 |   |
| Diluted                                                                |       | $          | 0.13       |       | $          | 0.01 |   |
|                                                                   |       |       |       |       |       |
| WEIGHTED AVERAGE NUMBER OF COMMON SHARES  OUTSTANDING:                 |       |       |       |       |       |
|                                                                   |       |       |       |       |       |
| Basic                                                                  |       | 61,464,761 |       | 57,161,701 |       |
| Diluted                                                                |       | 67,342,539 |       | 64,811,753 |       |

 

----

(1) Includes stock-based compensation expense of:

 
| ** **                             | ** ** | **Three months ended  March 31,** | ** ** |
|----------------------------------------|------------|--------------------------------------------------|------------|
| ** **                             | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
| ** **                             | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Cost of revenues                       |       | $                                                | 610        |   | $ | 1,558 |   |
| Research and development expenses      |       | 520                                              |       | 781 |   |
| Selling and marketing expenses         |       | 338                                              |       | 321 |   |
| General and administrative expenses    |       | 340                                              |       | 701 |   |
| Total stock-based compensation expense |       | $                                                | 1,808      |   | $ | 3,361 |   |

 

See notes tocondensed consolidated financial statements.

 

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**RISKMETRICSGROUP, INC.**

 

**CONDENSED CONSOLIDATED STATEMENTS OF CHANGESIN STOCKHOLDERS’ EQUITY**

**FORTHE THREE MONTHS ENDED MARCH 31, 2009**

 

**(UNAUDITED)**

 

**(Inthousands, except share amounts)**

 
| ** **                                                                     | ** ** | **Common Shares**                 | ** ** | ** ** | ** ** | **Additional**      | ** ** | **Accumulated  Other** | ** ** | ** **              | ** ** | **Total**                | ** ** |
|--------------------------------------------------------------------------------|------------|----------------------------------------|------------|------------|------------|---------------------|------------|------------------------|------------|-------------------------|------------|--------------------------|------------|
| ** **                                                                     | ** ** | **Number of  Shares Issued** | ** ** | **Amount** | ** ** | **Treasury  Stock** | ** ** | **Paid-In  Capital**   | ** ** | **Comprehensive  Loss** | ** ** | **Accumulated  Deficit** | ** ** | **Stockholders’  Equity** | ** ** |
|                                                                           |       |                                   |       |       |       |                |       |                   |       |                    |       |                     |       |   |   |
| BALANCE—January 1,  2009                                             |       | 61,673,960                             |       | $          | 617        |                | $          | (579                   | )          | $                       | 431,781    |                     | $          | (17,255 | ) | $ | (211,397 | ) | $ | 203,167 |   |
| Comprehensive  income:                                                         |       |                                   |       |       |       |                |       |                   |       |                    |       |                     |       |   |   |
| Net income                                                                     |       | —                                 |       | —     |       | —              |       | —                 |       | —                  |       | 8,527                    |       | 8,527 |   |
| Foreign currency  translation adjustment                                       |       | —                                 |       | —     |       | —              |       | —                 |       | (154                    | )          | —                   |       | (154 | ) |
| Net unrealized  gain on cash flow hedge, net of deferred tax liability of $590 |       | —                                 |       | —     |       | —              |       | —                 |       | 962                     |       | —                   |       | 962 |   |
| Total  comprehensive income                                                    |       | —                                 |       | —     |       | —              |       | —                 |       | —                  |       | —                   |       | 9,335 |   |
|                                                                           |       |                                   |       |       |       |                |       |                   |       |                    |       |                     |       |   |   |
| Common shares  issued upon exercise of stock options                           |       | 86,350                                 |       | 1          |       | —              |       | 220                    |       | —                  |       | —                   |       | 221 |   |
| Tax benefit  associated with exercise of stock options                         |       | —                                 |       | —     |       | —              |       | 292                    |       | —                  |       | —                   |       | 292 |   |
| Stock-based  compensation                                                      |       | —                                 |       | —     |       | —              |       | 1,808                  |       | —                  |       | —                   |       | 1,808 |   |
| Issuance of  common stock (Note 11)                                            |       | 14,014                                 |       | —     |       | —              |       | —                 |       | —                  |       | —                   |       | — |   |
|                                                                           |       |                                   |       |       |       |                |       |                   |       |                    |       |                     |       |   |   |
| BALANCE—March 31,  2009                                              |       | 61,774,324                             |       | $          | 618        |                | $          | (579                   | )          | $                       | 434,101    |                     | $          | (16,447 | ) | $ | (202,870 | ) | $ | 214,823 |   |
|                                                                           |       |                                   |       |       |       |                |       |                   |       |                    |       |                     |       |   |   |
| Disclosure of  realized loss:                                                  |       |                                   |       |       |       |                |       |                   |       |                    |       |                     |       |   |   |
| Unrealized loss  on cash flow hedge                                            |       | $                                      | (614       | )          |       |                |       |                   |       |                    |       |                     |       |   |   |   |
| Realized loss for  cash flow hedge settlement, net of tax benefit (Note 8)     |       | (1,576                                 | )          |       |       |                |       |                   |       |                    |       |                     |       |   |   |
| Net unrealized  gain on cash flow hedge                                        |       | $                                      | 962        |       |       |                |       |                   |       |                    |       |                     |       |   |   |   |

 

See notes tocondensed consolidated financial statements.

 

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**RISKMETRICSGROUP, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**FOR THETHREE MONTHS ENDED MARCH 31, 2009 AND 2008**

**(UNAUDITED)****(Amountsin thousands)**

 
| ** **                                                                                | ** ** | **2009**   | ** ** | **2008**   | ** ** |
|-------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| CASH FLOWS FROM OPERATING ACTIVITIES:                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                           |       | $          | 8,527      |       | $          | 347 |   |
| Adjustments to reconcile net income to net  cash provided (used) by operating activities: |       |       |       |       |       |
| Depreciation and amortization of property  and equipment                                  |       | 1,955      |       | 2,115      |       |
| Provision for bad debts                                                                   |       | 266        |       | 176        |       |
| Amortization of intangible assets                                                         |       | 5,592      |       | 5,456      |       |
| Amortization of debt issuance costs                                                       |       | 260        |       | 2,670      |       |
| Stock-based compensation                                                                  |       | 1,808      |       | 3,361      |       |
| Tax benefit associated with exercise of  stock options                                    |       | (292       | )          | (1,458     | )          |
| Loss on disposal of fixed assets                                                          |       | —     |       | 22         |       |
| Changes in assets and liabilities (net of  assets and liabilities acquired):              |       |       |       |       |       |
| Increase in accounts receivable                                                           |       | (9,118     | )          | (19,550    | )          |
| Decrease (increase) in income and deferred  taxes                                         |       | 4,901      |       | (632       | )          |
| Increase in other receivables and prepaid  expenses                                       |       | (1,650     | )          | (264       | )          |
| Increase in other assets                                                                  |       | (824       | )          | (54        | )          |
| Increase in deferred revenue                                                              |       | 10,421     |       | 11,062     |       |
| Increase (decrease) in trade accounts  payable                                            |       | 2,826      |       | (2,828     | )          |
| Decrease in accrued expenses and other  liabilities                                       |       | (20,376    | )          | (13,362    | )          |
| Net cash provided (used) by operating  activities                                         |       | 4,296      |       | (12,939    | )          |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                     |       |       |       |       |       |
| Purchases of property and equipment                                                       |       | (608       | )          | (1,777     | )          |
| Cash paid to acquire Innovest (net of cash  acquired of $1,190)                           |       | (14,883    | )          | —     |       |
| Net cash used in investing activities                                                     |       | (15,492    | )          | (1,777     | )          |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                     |       |       |       |       |       |
| Repayment of debt                                                                         |       | —     |       | (125,750   | )          |
| Gross proceeds from equity offering                                                       |       | —     |       | 197,400    |       |
| Equity offering expenses                                                                  |       | —     |       | (1,073     | )          |
| Excess tax benefit associated with exercise  of stock options                             |       | 292        |       | 1,458      |       |
| Proceeds from exercise of stock options                                                   |       | 221        |       | 2,682      |       |
| Net cash provided by financing activities                                                 |       | 513        |       | 74,717     |       |
| EFFECT OF EXCHANGE RATE CHANGES ON CASH                                                   |       | (788       | )          | (109       | )          |
| NET (DECREASE) INCREASE IN CASH AND CASH  EQUIVALENTS                                     |       | (11,471    | )          | 59,892     |       |
| CASH AND CASH EQUIVALENTS—Beginning of  period                                       |       | 170,799    |       | 27,455     |       |
| CASH AND CASH EQUIVALENTS—End of period                                              |       | $          | 159,328    |       | $          | 87,347 |   |
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW  INFORMATION:                                       |       |       |       |       |       |
| Cash paid for interest                                                                    |       | $          | 5,055      |       | $          | 6,472 |   |
| Cash paid for taxes                                                                       |       | $          | 510        |       | $          | 1,651 |   |
| NON CASH INVESTING AND FINANCING  ACTIVITIES:                                             |       |       |       |       |       |
| Tax benefit associated with exercise of ISS  stock options                                |       | $          | —     |       | $          | 596 |   |

 

See notes tocondensed consolidated financial statements.

 

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**RISKMETRICS GROUP, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**FOR THETHREE MONTHS ENDED MARCH 31, 2009**

**(UNAUDITED)**

 

**(Unlessindicated otherwise, all amounts in thousands, except share and per shareamounts)**

 

**1. OVERVIEW AND BASIS OF PRESENTATION**

 

***Company Overview***—RiskMetricsGroup, Inc. (“the Company” or “RMG”) is a provider of risk management andcorporate governance products and services to participants in the globalfinancial markets. The Company’s products and services enable its clients tobetter understand and manage the risks associated with their financialholdings, provide greater transparency to their internal and externalconstituencies, satisfy regulatory and reporting requirements and make moreinformed investment decisions. The Company provides its products and servicesacross multiple asset classes, markets and geographies to a diverse client baseincluding asset managers, hedge funds, pension funds, banks, insurancecompanies, financial advisors and corporations. The Company operates in twobusiness segments, the “RiskMetrics business” and the “ISS business”.

*** ***

***Principles ofConsolidation and Basis of Presentation***—Thecondensed consolidated financial statements include the accounts of RMG and itswholly owned-subsidiaries which are prepared in accordance with accountingprinciples generally accepted in the United States of America (“US GAAP”).All intercompany accounts and transactions have been eliminated inconsolidation.

 

The accompanying unaudited condensed consolidated financial statementshave been prepared pursuant to the rules of the Securities and ExchangeCommission (the “SEC”). Certain information and footnote disclosures normallyincluded in financial statements prepared in accordance with US GAAP have beencondensed or omitted pursuant to SEC rules. These financial statements shouldbe read in conjunction with the Company’s Annual Report on Form 10-K forthe year ended December 31, 2008.

 

The condensed consolidated financial statements as of March 31,2009 and for the three months ended March 31, 2009 and 2008 in the opinionof management, include all adjustments, consisting only of normal recurringaccruals, necessary to present fairly the Company’s financial position, resultsof operations and cash flows. The operating results for the three months ended March 31,2009 are not necessarily indicative of the results to be expected for the fullyear.  The December 31, 2008 condensed consolidated financialstatement information has been derived from the 2008 audited consolidatedfinancial statements.

 

**2.SIGNIFICANT ACCOUNTING POLICIES AND RECENT ACCOUNTING PRONOUNCEMENTS**

 

***Use of Estimates and Significant AccountingPolicies****—*The preparationof condensed consolidated financial statements in conformity with US GAAPrequires management to make estimates, judgments and assumptions that affectthe reported amounts of assets and liabilities and disclosure of contingentassets and liabilities at the date of the condensed consolidated financialstatements and the reported amounts of revenues and expenses during thereporting period. Significant estimatesand assumptions made by management include the deferral and recognition ofrevenue, impairment of goodwill and intangible assets, the fair value ofacquired assets and liabilities, stock-based compensation, gains or losses onderivative instruments, accounting for income taxes and other matters thataffect the condensed consolidated financial statements and relateddisclosures.  There have been no changes to the Company’s significantaccounting policies since December 31, 2008 other than as discussed below.

 

***Effects of Recently Issued AccountingStandards***—On December 4, 2007, the FinancialAccounting Standards Board (“FASB”) issued Statement No. 141(R), *Business Combinations* (SFAS 141(R))and Statement No. 160, *Accounting andReporting of Noncontrolling Interests in Consolidated Financial Statements*,an amendment of ARB No. 51 (SFAS 160). These new standardssignificantly change the financial accounting and reporting of businesscombination transactions and noncontrolling (previously minority) interests inconsolidated financial statements. SFAS 141(R) is required to beadopted concurrently with SFAS. 160 and was effective for businesscombination transactions for which the acquisition date is on or after thebeginning of the first annual reporting period beginning on or after December 15,2008. Application of SFAS 141(R) and SFAS 160 is generally requiredto be adopted prospectively, except for certain provisions of SFAS 141(R) andSFAS 160, which are required to be adopted retrospectively upon adoption.Business combination transactions accounted for before adoption ofSFAS 141(R) should be accounted for in accordance withSFAS141 and that accounting previously completed under SFAS 141 should notbe modified as of or after the date of adoption of Statement No.141(R).TheCompany 

 

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adopted SFAS 141R and SFAS 160 effective January 1, 2009 and theimpact of such adoption will be dependent upon the business combinations theCompany pursues.  The Company accounted for the acquisition of InnovestStrategic Value Advisors, Inc. (“Innovest”) in accordance with SFAS 141R (seeNote 4).

 

InMarch 2008, the FASB issued SFAS No. 161, “*Disclosures about Derivative Instruments and Hedging Activities, anamendment of FASB**Statement No. 133*”(“SFAS 161”). SFAS 161 establishes, among other things, thedisclosure requirements for derivative instruments and for hedging activities.The Company adopted SFAS 161 on January 1, 2009 and has included therequired disclosures regarding the fair value of derivative instruments in Note8.

 

InApril 2008, the FASB issued FASB staff position (“FSP”) FAS 142-3, *Determination of the Useful Life of Intangible Assets*(“FSP FAS 142-3”). FSP FAS 142-3 amends the factors an entity should considerin developing renewal or extension assumptions used in determining the usefullife of recognized intangible assets under FASB Statement No. 142, “Goodwilland Other Intangible Assets”. This new guidance applies prospectively tointangible assets that are acquired individually or with a group of otherassets in business combinations and asset acquisitions. The Company adopted FSPFAS 142-3 on January 1, 2009 and such adoption did not have a materialimpact on the condensed consolidated financial statements.

 

In April 2009,the FASB issued FSP No. FAS 107-1 and APB 28-1, “Interim Disclosures aboutFair Value of Financial Instruments.” This FSP essentially expands thedisclosure about fair value of financial instruments that were previouslyrequired only annually to also be required for interim period reporting. Inaddition, the FSP requires certain additional disclosures regarding the methodsand significant assumptions used to estimate the fair value of financialinstruments. These additional disclosures will be required beginning with thequarter ending June 30, 2009. The Company is currently evaluating therequirements of these additional disclosures.

 

**3. INITIAL PUBLIC OFFERING**

 

In January 2008, the Company completedan initial public offering of 16,100,000 shares of common stock, which included4,035,816 shares sold by selling stockholders and 2,100,000 shares to coverover-allotments, which was exercised in full in January 2008. The Companydid not receive any proceeds from the sale of the shares by the sellingstockholders. Net proceeds from the offering, including the exercise of theunderwriters’ allotment, were $193.9 million, after deducting underwritingdiscounts and commissions and approximately $3.5 million of offeringexpenses, of which $1.1 million were paid during the three months ended March 31,2008. The Company utilized a portion of the proceeds to prepay the entireoutstanding indebtedness under the Company’s second loan lien credit facility(See Note 7).

 

**4. INNOVEST ACQUISITION**

 

On March 2, 2009, the Company acquired all of the outstandingcommon stock of Innovest for $16.1 million in cash.  Innovest is an international investmentresearch and advisory firm specializing in analyzing “non-traditional” driversof risk and shareholder value, including companies’ performance onenvironmental, social and strategic governance issues.  The purpose of this acquisition is to enhancethe product offerings and services the Company may offer its customers inassessing risk within the environmental, social and governance sectors.  The acquisition has been accounted for as apurchase, and the operating results of Innovest have been included within theISS segment in the condensed consolidated financial statements since the dateof its acquisition.

 

The aggregate consideration paid for theacquisition is as follows:

 
| Total cash purchase consideration |   | $     | 16,073 |   |
|-----------------------------------|--------|-------|--------|--------|
| Less: cash acquired               |   | 1,190 |   |
| Total cash paid                   |   | $     | 14,883 |   |

 

The following table summarizes the amounts allocated to the acquiredassets and liabilities assumed based on management’s estimates:

 

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| Cash                                            |   | 1,190  |   |
|-------------------------------------------------|--------|--------|--------|
| Accounts receivable                             |   | 1,256  |   |
| Property and equipment and non current  assets  |   | 259    |   |
| Deferred tax assets                             |   | 1,934  |   |
| Intangible assets                               |   | 6,100  |   |
| Goodwill                                        |   | 10,046 |   |
| Total assets acquired                           |   | 20,785 |   |
| Accounts payable                                |   | (18    | )      |
| Accrued expenses and other current  liabilities |   | (633   | )      |
| Deferred tax liability                          |   | (2,416 | )      |
| Deferred revenue                                |   | (1,645 | )      |
| Net assets acquired                             |   | $      | 16,073 |   |
| Goodwill                                        |   | 10,046 |   |
| Identifiable intangible assets                  |   | 6,100  |   |
| Net liabilities assumed                         |   | (73    | )      |
| Total purchase consideration                    |   | $      | 16,073 |   |

 

In accordance with SFAS No. 109, *Accounting for Income Taxes*, the Companyhas provided for a deferred tax liability representing the difference betweenthe estimated book and tax basis of the net assets acquired. The excess of thepurchase price over the estimated fair values of the assets acquired andliabilities assumed was allocated to goodwill, which is not expected to bedeductible for tax purposes. The Company recorded a deferred tax asset foracquired net operating losses which are expected to be utilized over a periodof approximately 6 years.

 

Revenue included in the condensedconsolidated statements of operations for the three months ended March 31,2009 pertaining to Innovest was approximately $0.6 million and net earningswere not significant.

 

The Company incurred acquisition relatedexpenses of $0.2 million in connection with the acquisition and such costs areincluded in general and administrative costs in the accompanying condensedconsolidated statement of operations for the three months ended March 31,2009. In addition, the purchase consideration was reduced by $0.2 millionof employee severance costs and during the three months ended March 31,2009 the Company incurred a total of $0.5 million of employee severance costsas a result of reorganizing the ISS business due to the Innovest acquisition. Such expenses have been included in general and administrative expenses in theaccompanying statement of operations.

 

The purchase price for Innovest wasdetermined based on a valuation of market value comparables and futureprojections of discounted cash flows. The Company believes the purchase pricereflects the financial prospects of the existing business as well as thesignificant opportunities for revenue growth, cost savings and other synergies,including the ability to cross-sell to one another’s clients, and offer morecomprehensive and diverse services. The value reflected in these elements ofthe purchase price does not meet the definition of an intangible asset underSFAS 141R and is therefore reflected as goodwill within the ISS segment.  The amounts and useful lives allocated tointangible assets were as follows:

 
| Customer relationships  |   | $   | 4,770  |         | 10 years |   |
|-------------------------|--------|-----|--------|--------------|---------------|--------|
| Covenant not to compete |   | 170 |   | 2 years |          |
| Trade name              |   | 560 |   | 1 year  |          |
| Customer contracts      |   | 290 |   | 1 year  |          |
| Proprietary process     |   | 310 |   | 5 years |          |
| Total intangible assets |   | $   | 6,100  |         |          |   |

 

The purchase price allocation for Innovest is not complete as theacquisition occurred in March 2009 and the Company is still in the processof reviewing the valuation of assets and liabilities acquired.

 

The following table summarizes unaudited pro forma financialinformation for the three months ended March 31, 2009 and 2008 assumingthe Innovest acquisition had occurred on January 1, 2008.

 
|                   |   | **2009**                                                          |   | **2008** |   |
|------------------------|--------|-------------------------------------------------------------------|--------|----------|--------|
|                   |   | **(in thousands, except per share  amounts)** |   |
| Revenues               |   | $                                                                 | 78,701 |     | $      | 72,842 |   |
| Income from operations |   | 18,333                                                            |   | 11,817   |   |
| Net income             |   | 8,167                                                             |   | 116      |   |
| Net income per share:  |   |                                                              |   |     |   |
| Diluted                |   | $                                                                 | 0.12   |     | $      | 0.00 |   |

 

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Theseunaudited pro forma results are intended for informational purposes only andare not necessarily indicative of the results of operations that would haveoccurred had the Innovest acquisition been in effect at the beginning of theperiods presented, or of future results of the combined operations.

 

**5. INTANGIBLE ASSETS AND GOODWILL**

 

Intangible assets as of March 31, 2009 and December 31, 2008consist of the following:

 
| ** **              | ** ** | **March 31, 2009** | ** ** |
|-------------------------|------------|------------------------------|------------|
| ** **              | ** ** | **Useful Lives**        | ** ** | **Gross** | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** |
| Customer relationships  |       | 7–11 years         |       | $ | 132,920 |   | $ | (26,907 | ) | $ | 106,013 |   |
| Acquired technology     |       | 5 years                 |       | 27,123 |   | (11,353 | ) | 15,770 |   |
| Covenant not to compete |       | 1–3 years          |       | 1,670 |   | (882 | ) | 788 |   |
| Proprietary process     |       | 5-7 years               |       | 9,180 |   | (2,117 | ) | 7,063 |   |
| Trade names             |       | 1–10 years         |       | 24,160 |   | (5,212 | ) | 18,948 |   |
| Customer contracts      |       | 1 year                  |       | 290 |   | (24 | ) | 266 |   |
| Total                   |       |                         |       | $ | 195,343 |   | $ | (46,495 | ) | $ | 148,848 |   |

 
| ** **              | ** ** | **December 31, 2008** | ** ** |
|-------------------------|------------|---------------------------------|------------|
| ** **              | ** ** | **Useful Lives**           | ** ** | **Gross** | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** |
| Customer relationships  |       | 7–11 years            |       | $ | 128,150 |   | $ | (23,751 | ) | $ | 104,399 |   |
| Acquired technology     |       | 5 years                    |       | 27,123 |   | (10,013 | ) | 17,110 |   |
| Covenant not to compete |       | 1–3 years             |       | 1,500 |   | (771 | ) | 729 |   |
| Proprietary process     |       | 7 years                    |       | 8,870 |   | (1,795 | ) | 7,075 |   |
| Trade names             |       | 1–10 years            |       | 23,600 |   | (4,573 | ) | 19,027 |   |
| Total                   |       |                            |       | $ | 189,243 |   | $ | (40,903 | ) | $ | 148,340 |   |

 

Annual amortization expense, which is basedon the values of intangibles and their useful lives, for the next five years,is expected to be as follows:

 
| Remainder of year ending December 31,  2009 |   | $      | 17,563 |   |
|--------------------------------------------------|--------|--------|--------|--------|
| Years ending December 31,                   |   |   |   |
| 2010                                             |   | $      | 22,605 |   |
| 2011                                             |   | $      | 22,080 |   |
| 2012                                             |   | $      | 17,188 |   |
| 2013                                             |   | $      | 16,918 |   |

 

Goodwill changed during the three monthsended March 31, 2009 as follows:

 
| Balance at January 1, 2009    |   | $      | 308,613 |   |
|------------------------------------|--------|--------|---------|--------|
| Goodwill from Innovest acquisition |   | 10,046 |    |
| Balance as of March 31, 2009  |   | $      | 318,659 |   |

 

**6. ACCRUED EXPENSES**

 

Accrued expenses as of March 31, 2009and December 31, 2008 consist of the following:

 

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| ** **                           | ** ** | **March 31,  2009** | ** ** | **December 31,  2008** | ** ** |
|--------------------------------------|------------|--------------------------|------------|------------------------|------------|
| Accrued compensation and related tax |       | $                        | 11,901     |                   | $          | 29,492 |   |
| Accrued data expense                 |       | 1,379                    |       | 1,907                  |       |
| Accrued travel and entertainment     |       | 359                      |       | 393                    |       |
| Accrued professional fees            |       | 1,132                    |       | 1,392                  |       |
| Current portion of deferred rent     |       | 203                      |       | 273                    |       |
| Other accrued expenses               |       | 5,572                    |       | 6,717                  |       |
|                                 |       | $                        | 20,546     |                   | $          | 40,174 |   |

 

**7. DEBT**

 

 TheCompany’s debt is comprised of two term loan facilities and a revolving creditfacility.  As of March 31, 2009, andDecember 31, 2008, $290.6 million of debt remains outstanding under thefirst lien loan and no indebtedness remains outstanding under the second lienterm loan or revolving credit facility. The maturity date of the first lien term loan is December 2013.

 

The first lien credit facilities consists ofa $25 million revolving credit facility and $300 million of firstlien term loan facility and accumulates interest, at the option of the Companyat: (a) the LIBOR rate plus a margin of 1.75% to 2.25% depending on theCompany’s consolidated leverage ratio, or (b) the higher of (i) theFederal Funds Effective Rate plus 0.5% and (ii) Bank of America’s “primerate,” plus a margin of 0.75% or 1.25% depending on the consolidated leverageratio.  Amounts repaid under the firstlien term loan facility may not be re-borrowed. Amounts repaid under therevolving credit facility may be re-borrowed.

 

The second lien term loan facility was for$125 million and accumulated interest based on, at the option of theCompany at: (a) the LIBOR rate plus a margin of 5.50%, or (b) thehigher of (i) the Federal Funds Effective Rate plus 5.0% and (ii) Bankof America’s “prime rate,” plus a margin of 4.50%. In January 2008, theCompany utilized a portion of proceeds from the initial public offering toprepay the entire outstanding indebtedness under the second lien loan, in theamount of $125.0 million. In addition, the Company paid a 1% prepaymentpenalty fee, or $1.25 million, upon repayment as set forth in the creditagreement, which has been included in other expenses for the three months endedMarch 31, 2008.

 

The effective interest rate on the Company’sdebt was 7.1% and 7.9% for the three months ended March 31, 2009 and 2008,respectively.

 

In addition to quarterly interest paymentsdue on the credit facility, the Company is required to repay the principalamounts of the first lien credit facility in quarterly installments of $741, ofwhich the next payment is due on June 30, 2009. Furthermore, the Companyis required to make a mandatory payment equal to each year’s excess cash flowdepending on leverage ratios, as defined in the first lien term loan facility,within five days of delivery of audited financial statements. Based on theCompany’s consolidated leverage ratio as of March 31, 2009, no futureexcess cash flow payments would be required as long as that ratio ismaintained. The Company is required to repay the aggregate principal remainingon the first lien term loan facility on the maturity date. The Company mayvoluntarily prepay the first lien credit facilities in whole or in part withoutpenalty.

 

Scheduled repayments of balances outstandingas of March 31, 2009 are as follows:

 
| For the twelve months ending March 31, |   |    |    |
|---------------------------------------------|--------|---------|---------|
| 2010                                        |   | $       | 2,965   |   |
| 2011                                        |   | 2,966   |    |
| 2012                                        |   | 2,966   |    |
| 2013                                        |   | 2,966   |    |
| 2014                                        |   | 278,756 |    |
|                                        |   | $       | 290,619 |   |

 

The Company has guaranteed the payment andperformance of the credit facilities. The Company has pledged all of its assetsas collateral against the debt.

 

The Company incurred debt issuance costs of$10,074, which have been recorded on the accompanying condensed consolidatedbalance sheet, net of amortization. Such amount is being amortized over thelife of the remaining debt and is reflected as a component of interest expenseon the accompanying statement of operations. In conjunction with the 

 

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prepayment of the second lien loan during the three months ended March 31,2008, the Company wrote-off debt issuance costs of $2,377.  The following table summarizes amortizationof debt issuance costs, including the write-off of debt issuance costs in theaccompanying condensed consolidated statements of operations:

 
| ** **                          | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------------|------------|--------------------------------------------------|------------|
| ** **                          | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
| Amortization of debt issuance costs |       | $                                                | 260        |   | $ | 2,670 |   |
|                                     |            |                                                  |            |  |  |  |  |

 

**8. FAIR VALUE OF DERIVATIVE INSTRUMENTS**

 

TheCompany utilizes market data or assumptions that the Company believes marketparticipants would use in pricing the fair value asset or liability ofderivative instruments, including assumptions about risk and the risks inherentin the inputs to the valuation technique. These inputs can be readilyobservable quoted prices in active markets for identical assets or liabilities(level 1), significant other observable inputs (level 2) or significantunobservable inputs (level 3).The Company primarily uses the income approach, which uses valuationtechniques to convert future amounts to a single present amount. As of March 31,2009 the Company had interest rate swap agreements which are valued using level2 inputs as shown in the following table:

 
| ** **                                  | ** ** | ** ** | ** ** | **Fair value at March 31, 2009, using:** | ** ** |
|---------------------------------------------|------------|------------|------------|------------------------------------------------------------------------|------------|
| ** **                                  | ** ** | ** ** | ** ** | **Quoted prices in**                                         | ** ** | **Significant** | ** ** | **Significant** | ** ** |
| ** **                                  | ** ** | ** ** | ** ** | **active markets for**                                       | ** ** | **other** | ** ** | **unobservable** | ** ** |
| ** **                                  | ** ** | ** ** | ** ** | **identical assets**                                              | ** ** | **observable inputs** | ** ** | **Inputs** | ** ** |
| ** **                                  | ** ** | **Total**  | ** ** | **(Level 1)**                                                     | ** ** | **(Level 2)** | ** ** | **(Level 3)** | ** ** |
| Interest rate swap liability                |       | $          | 20,758     |                                                                   | $          | — |   | $ | 20,758 |   | $ | — |   |
| Total included in other long term liability |       | $          | 20,758     |                                                                   | $          | — |   | $ | 20,758 |   | $ | — |   |

 

In February 2007, the Company enteredinto two interest-rate swap agreements to reduce interest rate risks and tomanage interest expense. By entering into these agreements, the Company changedthe fixed/variable interest-rate mix of its debt portfolio. The agreementseffectively convert floating-rate debt into fixed-rate debt over the maturitylife of the debt. This reduces the Company’s risk of incurring higher interestcosts in periods of rising interest rates and increases the Company’s risk ofpaying higher interest costs in periods of decreasing interest rates. Theinterest rate swap agreements adjusted the Company’s weighted average effectiveinterest rate, which resulted in a gain (loss) being recorded in interestexpense in the accompanying condensed consolidated statements of operations.

 

The Company’s interest-rate swap agreementshedge a substantial portion of the interest rate risk exposure under theCompany’s debt (see Note 7). As of March 31, 2009 and December 31,2008, the swap agreements had a notional amount of $253,050 and $279,375,respectively. As of March 31, 2009 and December 31, 2008, the swapagreements had a fair value liability of $20,758 and $22,311, respectively,which is included in other long-term liabilities on the accompanying condensedconsolidated balance sheets.

 

In conjunction with the prepayment of thesecond lien term loan during the three months ended March 31, 2008 (Note7), the Company reduced the notional amount of the interest rate swap by$19,300 in order to hedge the remaining debt outstanding.  The cost for the reduction of the notionalwas $1,364 and has been included in other expenses on the accompanyingcondensed consolidated statement of operations for the three months ended March 31,2008.

 

The notional amount of the swap amortizesover the life of the debt and results in gains and losses being recognized ininterest expense in the accompanying condensed consolidated statements ofoperations. The (loss) gain from the amortization and reduction of the swapagreement is summarized in the following table:

 
| ** **                      | ** ** | **Three Months Ended  March 31,** |
|---------------------------------|------------|--------------------------------------------------|
| ** **                      | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
| (Loss) gain from swap agreement |       | $                                                | (2,542 | ) | $ | (215 | ) |
|                                 |            |                                                  |  |  |  |  |  |

 

These hedges of interest rate risk relatingto the Company’s debt have been designated as effective cash flow hedges atinception and on an ongoing quarterly basis. The Company estimates theeffectiveness of the interest rate swap agreement utilizing the hypotheticalderivative method. Under this method, the fair value of the actual interestrate swap agreement is compared to the fair value of a hypothetical swapagreement. To the extent that the agreement is not considered to be highlyeffective in offsetting the change in the value of the interest payments beinghedged, the fair value relating to the ineffective 

 

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portion of such agreement and any subsequent changes in such fair valuewill be immediately recognized in earnings. To the extent that the agreement isconsidered highly effective but not completely effective in offsetting thechange in the value of the interest payments being hedged, any changes in fairvalue relating to the ineffective portion of such agreement will be immediatelyrecognized in earnings. Effective gains and losses have been included in theunrealized loss on cash flow hedges as a component of other comprehensiveincome, net of tax.

 

**9. INCOME TAXES**

 

The Company’s effective tax rate for theprovision for income taxes was 36.9% and 39.5% for the three months ended March 31,2009 and 2008, respectively.  The effective tax rate of 36.9% for thethree months ended March 31, 2009 reflects the Company’s estimate of theeffective tax rate during the period.

 

As of March 31, 2009, the Company’sunrecognized tax benefits totaled $2,118, all of which would favorably impactthe Company’s effective tax rate, if recognized. Over the next nine months, anincrease of $302 will be recorded for unrecognized tax benefits and suchincrease will unfavorably impact the Company’s income tax provision.  Interest and penalties accrued during thethree months ended March 31, 2009 and 2008 were $32 and $198,respectively.

 

The Company’s tax returns for 2005-2007remain open to examination by the Internal Revenue Service in their entirety.They also remain open with respect to international and state taxingjurisdictions. Currently, the Company (or one of its subsidiaries) has beenselected for audit by the Internal Revenue Service for 2006 and 2007, New YorkCity for 2004-2006, and Canada Revenue Agency for 2005-2006. As of March 312009 and December 31, 2008, $489 and $457 were accrued for the payment ofinterest and penalties, respectively.

 

A reconciliation of the beginning and endingamount of unrecognized gross tax benefits is as follows:

 
| Balance at January 1, 2009                               |   | $      | 2,017  |   |
|---------------------------------------------------------------|--------|--------|--------|--------|
| Additions based on tax positions related to  the current year |   | 69     |   |
| Additions for tax positions of prior years                    |   | 32     |   |
| Reductions for tax positions of prior years                   |   | — |   |
| Balance as of March 31, 2009                             |   | $      | 2,118  |   |

 

**10. COMMITMENTS AND CONTINGENCIES**

 

The Company is committed to unrelated partiesfor the rental of office space under operating leases. As of March 31, 2009,minimum future rental payments under operating leases are as follows:

 
| For the twelve months ending March 31, |   |   |   |
|---------------------------------------------|--------|--------|--------|
| 2010                                        |   | $      | 7,259  |   |
| 2011                                        |   | 7,146  |   |
| 2012                                        |   | 6,733  |   |
| 2013                                        |   | 4,160  |   |
| 2014                                        |   | 2,309  |   |
| Thereafter                                  |   | 6,409  |   |
| Total minimum lease payments                |   | $      | 34,016 |   |

 

During the three months ended March 31, 2009 the Company signed an11 year operating lease agreement for its new ISS headquarters in Rockville,Maryland for a total rent commitment of approximately $10.4million.   The term of the lease agreement does not commence untilthe facilities are completed by the lessor and are ready for occupancy, whichis expected to occur during the second half of 2009.   The leaseincludes certain free rent periods and lease escalation clauses, however, theCompany will record rent expense on a straight-line basis each month beginningupon commencement of the lease.

 

During the three months ended March 31, 2009 and 2008 the Companyincurred lease exit costs of $607 and $198, respectively, as a result of movingvarious Company operations.  Such expenses have been included in generaland administrative expenses in the accompanying condensed consolidatedstatements of operations.

 

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***Data Agreements***—TheCompany has entered into agreements with various vendors to supply the Companywith data. The aggregate minimum payments with respect to these data agreementsas of March 31, 2009, are as follows:

 
| For the twelve months ending March 31, |   |   |   |
|---------------------------------------------|--------|--------|--------|
| 2010                                        |   | $      | 7,482  |   |
| 2011                                        |   | 1,720  |   |
| 2012                                        |   | 91     |   |
| Total                                       |   | $      | 9,293  |   |

 

***Contingencies***—TheCompany has no pending litigation matters against it that it considers to bematerial nor has the Company initiated any litigation against any parties.

 

**11. STOCK-BASED COMPENSATION**

 

The Company has incentive plans that providefor the issuance of equity awards, including stock options and non-vestedshares of our common stock (“non-vested stock”).

 

*Stock Options*

 

During 2000, the Company’s Board of Directorsadopted a Stock Option Plan (the “2000 Plan”) that provided for the grant ofoptions to employees, consultants, and non-employee directors to purchasecommon stock, which vest over a one to four year period and have a ten-yearcontractual term. The maximum number of shares of the Company’s common stockavailable for issuance under the 2000 Plan was 12,500,000, and no more than4,000,000 were allowed to be issued in any calendar year. The Company retiredthe 2000 Plan and adopted a new option plan (the “2004 Plan”). As of March 31,2009, 5,518,034 options issued under the 2000 Plan remain outstanding.

 

The 2004 Plan provides for the grant ofoptions to employees, consultants, and non-employee directors to purchasecommon stock, which vest over a three to four year period and have a ten-yearcontractual term. To satisfy options granted under the Plan, the Company maymake common stock available from authorized but unissued shares or shares heldin treasury by the Company. The maximum number of shares of the Company’scommon stock available for issuance under the 2004 Plan is 7,500,000. TheCompany retired the 2004 plan and adopted a new option plan (the “2007 plan”).As of March 31, 2009, 4,361,193 options issued under the 2004 Plan remainoutstanding.

 

In January 2007, the Company’s Board ofDirectors adopted a stock option plan covering the employees from ISS (the “ISSPlan”), which resulted in the rollover of 1,396,000 fully-vested options. Underthe adoption of this ISS Plan, no additional options are to be issued. As of March 31,2009, 160,242 options issued under the ISS Plan remain outstanding.

 

In January 2007 the Company’s Board ofDirectors adopted a Stock Option Plan (the “2007 Plan”) that provides for thegrant of options and non-vested stock to employees, consultants, andnon-employee directors to purchase common stock, which vest over a four yearperiod and have a ten-year contractual term. The maximum number of shares ofthe Company’s common stock available for issuance under the 2007 Plan is6,500,000. As of March 31, 2009, 3,516,060 options and 223,559 shares ofnon-vested stock granted under the 2007 Plan remain outstanding.

 

Summarized information relative to theCompany’s stock option plans is as follows:

 
| ** **                            | ** ** | **Number of  Shares** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
|---------------------------------------|------------|----------------------------|------------|-----------------------------------------|------------|
| Outstanding—January 1, 2009 |       | 12,819,587                 |       | $                                       | 7.20       |   |
| Granted                               |       | 973,500                    |       | $                                       | 11.82      |   |
| Exercised                             |       | (86,350                    | )          | $                                       | 2.56       |   |
| Forfeited                             |       | (151,208                   | )          | $                                       | 16.69      |   |
| Outstanding—March 31, 2009  |       | 13,555,529                 |       | $                                       | 7.46       |   |

 

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The Company’s stock options outstanding as of March 31, 2009 wereas follows:

 
| ** **                         | ** ** | **Outstanding Options** | ** ** | **Options Exercisable**                                        | ** ** |
|------------------------------------|------------|------------------------------|------------|---------------------------------------------------------------------|------------|
| **Range of  Exercise  Price** | ** ** | **Number of  Options**  | ** ** | **Weighted-Average  Remaining  Contractual  Life  (In Years)** | ** ** | **Weighted-Average  Exercise  Price** | ** ** | **Number of  Options** | ** ** | **Weighted-Average  Exercise  Price** | ** ** |
| $                                  | 1.00-5.00  |                         | 7,075,264  |                                                                | 4.05       |   | $ | 2.54 |   | 7,070,887 |   | $ | 2.54 |   |
| 5.01-10.00                         |       | 1,913,941                    |       | 6.76                                                                |       | 7.02 |   | 1,402,403 |   | 7.02 |   |
| 10.01-15.00                        |       | 961,500                      |       | 9.91                                                                |       | 11.81 |   | — |   | — |   |
| 15.01-20.00                        |       | 3,604,824                    |       | 8.16                                                                |       | 16.21 |   | 1,553,387 |   | 16.21 |   |
|                               |       | 13,555,529                   |       | 5.94                                                                |       | $ | 7.34 |   | 10,026,677 |   | $ | 5.24 |   |
|                                    |            |                              |            |                                                                     |            |  |  |  |  |  |  |  |  |  |

 

Of the unvested options as of March 31,2009, 3,105,390 are expected to vest in the future.  As of March 31, 2009 the intrinsic valueof stock options outstanding and exercisable was approximately $94.2 millionand $90.7 million, respectively. The intrinsic value of stock options exercisedduring the three months ended March 31, 2009 was approximately $0.8million.

 

The fair value of stock options at date ofgrant was estimated using the Black-Scholes option-pricing model utilizing thefollowing weighted-average assumptions:

 
| ** **                      | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------------------|------------|--------------------------------------------------|------------|
| ** **                      | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
| Risk-free interest rate         |       | 2.0                                              | %          | 2.6 | % |
| Expected term (in years)        |       | 5.6                                              |       | 4.5 |   |
| Expected stock price volatility |       | 46                                               | %          | 35 | % |
| Expected dividend yield         |       | None                                             |       | None |   |

 

The weighted-average per share fair value ofoptions granted was as follows:

 
| ** **                                                | ** ** | **Three Months Ended  March 31,** | ** ** |
|-----------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
| Weighted average per share fair value of  options granted |       | $                                                | 5.27       |   | $ | 5.63 |   |
|                                                           |            |                                                  |            |  |  |  |  |

 

*Non-vested Stock*

 

The following table summarizes non-vestedstock activity for the three months ended March 31, 2009:

 
| ** **                              | ** ** | **Number of  Shares** | ** ** | **Weighted Average  Grant Date  Fair Value** | ** ** |
|-----------------------------------------|------------|----------------------------|------------|-------------------------------------------------------------|------------|
| Unvested shares at January 1, 2009 |       | 235,039                    |       | $                                                           | 18.01      |   |
| Granted                                 |       | 4,313                      |       | $                                                           | 13.02      |   |
| Vested                                  |       | (14,014                    | )          | $                                                           | 12.36      |   |
| Forfeited                               |       | (1,779                     | )          | $                                                           | 16.50      |   |
| Unvested Shares at March 31, 2009  |       | 223,559                    |       | $                                                           | 14.97      |   |

 

The total fair value of shares vested duringthe three months ended March 31, 2009 was $173.   As of March 31, 2009, there wasapproximately $17,286 of unrecognized compensation costs related to stockoptions and non-vested share-based compensation awards granted under the stockoption plans, which is expected to be recognized over a period of approximatelyfour years.

 

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**12. EARNINGS PER SHARE**

 

Basic earnings per common share are computedby dividing net income attributable to common shareholders by the weightedaverage number of common shares outstanding. Diluted earnings per common shareis computed by dividing net income attributable to common shareholders by adiluted weighted average number of common shares outstanding. Diluted earningsper common share reflects the potential dilution that would occur if securitiesor other contracts to issue common stock were exercised or converted into commonstock, unless they are anti-dilutive.

 

In computing earnings per share for the threemonths ended March 31, 2009 and 2008, the difference between basic anddiluted number of shares outstanding is as follows:

 
| ** **                                                                       | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                       | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
| Basic number of weighted-average shares  outstanding                             |       | 61,464,761                                       |       | 57,161,701 |   |
| Effect of dilutive securities— Employee  stock options and non-vested stock |       | 5,877,778                                        |       | 7,650,052 |   |
| Diluted number of weighted-average shares  outstanding                           |       | 67,342,539                                       |       | 64,811,753 |   |

 

Options and non-vested stock of 4,140,515 and1,341,138 common shares during the three months ended March 31, 2009 and2008, respectively, were anti-dilutive and were therefore excluded from thecomputation of diluted earnings per share.

 

**13. SEGMENT INFORMATION**

 

As of March 31, 2009, the Company hastwo reportable segments, the RiskMetrics business and the ISS business. Thesedesignations have been made as the discrete operating results of these segmentsare reviewed by the Company’s chief operating decision maker to assessperformance and make operating and asset allocation decisions. The Companyallocates corporate and other shared services to each segment based on theemployees’ geographic location, revenue allocation and headcount.

 

The RiskMetrics business is a provider ofmulti-asset, position-based risk and wealth management products and services.The business provides clients with comprehensive, interactive products andservices that allow them to measure and quantify portfolio risk across securitytypes, geographies and markets. The products and services enable the clients tomake

more informed investment decisions, monitor and comply with exposureand risk limits, provide greater transparency to both internal audiences andexternal constituencies and meet regulatory and reporting requirements.

 

The ISS business is a provider of corporategovernance services to institutional shareholders and corporations around theworld. The business facilitates the voting of proxies by institutional investorsand provides in-depth research and analysis to help inform their votingdecisions and assess issuer-specific risk. It offers both global securitycoverage and fully integrated products and services, from policy creation tocomprehensive research, vote recommendations, reliable vote execution,post-vote disclosure and reporting and analytical tools.

 

Results of operations by segment for the three months ended March 31,2009 and 2008 is as follows:

 
| ** **                                               | ** ** | **RiskMetrics  Business** | ** ** | **ISS  Business** | ** ** | **Total** | ** ** |
|----------------------------------------------------------|------------|---------------------------|------------|-------------------|------------|-----------|------------|
| **Three months ended March 31, 2009:**              |       |                      |       |              |       |      |       |
| Revenues                                                 |       | $                         | 40,194     |              | $          | 37,187    |       | $ | 77,381 |   |
| Depreciation and amortization of property  and equipment |       | 1,086                     |       | 869               |       | 1,955     |       |
| Amortization of intangible assets                        |       | 75                        |       | 5,517             |       | 5,592     |       |
| Other operating expenses                                 |       | 23,824                    |       | 27,309            |       | 51,133    |       |
| Income from operations                                   |       | $                         | 15,209     |              | $          | 3,492     |       | $ | 18,701 |   |
| Interest, dividend and investment income                 |       |                      |       |              |       | 193       |       |
| Interest expense                                         |       |                      |       |              |       | (5,386    | )          |
| Income before provision for income taxes                 |       |                      |       |              |       | 13,508    |       |
| Provision for income taxes                               |       |                      |       |              |       | 4,981     |       |
| Net income                                               |       |                      |       |              |       | $         | 8,527      |   |
| Asset information at March 31, 2009:                |       |                      |       |              |       |      |       |
| Segment assets                                           |       | $                         | 184,526    |              | $          | 526,397   |       | $ | 710,923 |   |
| Goodwill                                                 |       | $                         | —     |              | $          | 318,659   |       | $ | 318,659 |   |

 

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| ** **                                               | ** ** | **RiskMetrics  Business** | ** ** | **ISS  Business** | ** ** | **Total** | ** ** |
|----------------------------------------------------------|------------|---------------------------|------------|-------------------|------------|-----------|------------|
| **Three months ended March 31, 2008:**              |       |                      |       |              |       |      |       |
| Revenues                                                 |       | $                         | 34,436     |              | $          | 36,784    |       | $ | 71,220 |   |
| Depreciation and amortization of property  and equipment |       | 1,160                     |       | 955               |       | 2,115     |       |
| Amortization of intangible assets                        |       | —                    |       | 5,456             |       | 5,456     |       |
| Other operating expenses                                 |       | 23,989                    |       | 27,609            |       | 51,598    |       |
| Income from operations                                   |       | $                         | 9,287      |              | $          | 2,764     |       | $ | 12,051 |   |
| Interest, dividend and investment income                 |       |                      |       |              |       | 299       |       |
| Interest expense                                         |       |                      |       |              |       | (9,163    | )          |
| Interest expense                                         |       |                      |       |              |       | (2,613    | )          |
| Income before provision for income taxes                 |       |                      |       |              |       | 574       |       |
| Provision for income taxes                               |       |                      |       |              |       | 227       |       |
| Net income                                               |       |                      |       |              |       | $         | 347        |   |
| Asset information at March 31, 2008:                |       |                      |       |              |       |      |       |
| Segment assets                                           |       | $                         | 119,980    |              | $          | 693,350   |       | $ | 813,330 |   |
| Goodwill                                                 |       | —                    |       | $                 | 460,355    |      | $          | 460,355 |   |

 

**14. RELATED PARTY TRANSACTION**

 

In May 2008, the Company entered into a contract for the sale ofMarket Risk products to Duff Capital Advisors which expired on March 31,2009. Philip Duff, a director of the Company, is the founder, CEO and GeneralPartner of Duff Capital Advisors. The Company recognized revenue of $247 forthe Duff Capital Advisors contract for the three months ended March 31,2009.

 

**********

 

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**Item 2.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

 

*Unless the context otherwise indicates or requires, as usedin this Form 10-Q, references to “we,” “us,” “our” or the “company” referto RiskMetrics Group, Inc., and its subsidiaries. References to “RiskMetrics”refer only to our subsidiary, RiskMetrics Solutions, Inc. and itssubsidiaries, references to “ISS” refer only to our subsidiary InstitutionalShareholder Services, Inc. and its subsidiaries.  In this Form 10-Q,all dollar amounts are expressed in thousands, unless indicated otherwise.References to our “clients” include each business unit, division orwholly-owned subsidiary of a parent company which has entered into a separatecustomer contract with us.*

 

*The following discussion should be read in conjunction withour historical financial statements and the related notes included elsewhere inthis Form 10-Q and in our Annual Report on Form 10-K for the yearended December 31, 2008 (the “Form 10-K”). This discussion containsforward-looking statements that are subject to known and unknown risks anduncertainties. Actual results and timing of events may differ significantlyfrom those expressed or implied due to a number of factors, including those setforth in “Item 1A.—Risk Factors,” on our Form 10-K.*

 

**Overview**

 

We are a leading provider of risk managementand corporate governance products and services to participants in the globalfinancial markets, as measured by revenues. Our products and services enableinvestors to measure and manage the market, credit, portfolio, governance,accounting, legal and environmental risks associated with their financialholdings. These offerings address multiple asset classes, markets andgeographies to a broad group of market participants, including asset managers,hedge funds, pension funds, banks, insurance companies, financial advisors andcorporations. Clients rely on us to better understand and manage risk of theirfinancial holdings, to provide greater transparency to both their internal andexternal constituencies, to satisfy regulatory and reporting requirements andto make better investment decisions.

 

Our growth strategy is focused on thefollowing:

 

·                  increasingsales to existing clients by providing additional data, research, analyticalproducts and processing services, which we believe will be enhanced byleveraging our combined RiskMetrics and ISS sales forces;

 

·                  expandingour client base by further penetrating our markets, including expanding ourglobal footprint and attracting new clients, especially financial institutionswhich currently rely on internally developed risk management and proxy votingsolutions; and

 

·                  enhancingand extending our products and services, including the creation of new productand service offerings and by selectively pursuing acquisitions; whileleveraging the economies of scale in our cost structure to grow revenues at agreater rate than operating expenses and thereby increase our operating margin.

 

We benefit from a number of favorableattributes of our business model. These attributes include:

 

**Subscription-based revenue model:**  We sell our services primarily on an annualsubscription basis and have historically experienced high renewal rates.Recurring revenues accounted for approximately 91.4% of our total revenuesduring the three months ended March 31, 2009, and we had a renewal rate of83.5% during that time. Our subscription model and historically high renewal ratesminimize volatility in our revenues and provide significant visibility for ourfuture results.

 

**Leveragable cost structure:**  Because we provide our services from a commontechnology and data infrastructure, we benefit from economies of scale. As aresult, we have generally been able to increase margins as our revenues havegrown.

 

**Favorable cash flow characteristics:**  Our subscription-based revenues andleveragable cost structure, combined with our positive working capitalcharacteristics and low capital expenditure requirements, have historicallyallowed us to generate significant cash flow.

 

In evaluating our results, we focus onseveral key financial and operating data including annualized contract value,renewal rates, sales to new customers, non-recurring revenues and AdjustedEBITDA. Our annualized contract value, which is described in detail below, is aleading indicator of our business and represents a large portion of our revenuein any given period. We track our performance across geographies and productand service lines.

 

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We expect to invest in our business tocontinue to grow our revenues. Compensation, data acquisition and technologyinfrastructure costs represent significant components of our operating expensestructure. While we expect to increase our operating expenses over time to takeadvantage of market opportunities, we believe that the economies of scale inour operating model will allow us to grow our operating expenses at a lowerrate than revenues and thereby increase our operating margins.

 

Thevast majority of our business involves the sale of products and servicesto clients in the financial services industry, including asset managers,banks, insurance companies, hedge funds, pension funds as wellas professional organizations that serve the financial servicesindustry.  The global financial markets have been adversely impacted bythe current market environment that includes illiquidity, marketvolatility, widening credit spreads, changes in interest rates, currencyexchange fluctuations and new legal and compliancerequirements.  These market conditions and the reduced businessactivity have had a negative impact on a number of our clients and couldnegatively impact our future revenues due to the potential for declining salesand renewal rates.

 

Wedo not believe that our liquidity has been affected by the recent events in theglobal financial markets.  Refer toLiquidity and Capital Resources discussion.

 

***Our Revenues***

 

We generate a substantial majority of ourrevenues from annual subscriptions to our products and services, for which ourclients generally pay us in advance. These contracts generally renewautomatically on an annual basis. Our products and services are generallypriced based on the access to our applications and services, includingresearch, voting and reports purchased. We do not generally price our productsand services based on our clients’ assets under management (“AUM”). As aresult, we are not directly subject to revenue fluctuations resulting fromchanges in our clients’ AUM. Our experience has been that, over time, ourclients have often added users and purchased additional products and servicesfrom us, which has led to increases in our revenues per client.

 

Revenues from subscription contracts arereferred to as recurring revenues. Recurring revenues are generated through therenewal of existing contracts and the signing of new subscription contracts.For the three months ended March 31, 2009, approximately 91.4% of ourtotal revenues were generated from these subscription contracts. Thesubscription fees received from our clients are recorded as deferred revenuesand recognized each month as our services are rendered. Our renewal rate, whichwas 83.5% for the three months ended March 31, 2009, combined with ourlevel of new subscription contracts, determine our annualized contract value,which is a leading indicator of our recurring revenues. Our annualized contractvalue as of March 31, 2009 was $288.0 million.

 

We also generate non-recurring revenue fromsales of products and services without a subscription contract, whichrepresented 8.6% of total revenues during the three months ended March 31,2009.

 

*Annualized Contract Value (“ACV”)*

 

As a result of our subscription-based modeland historically high renewal rates, at the end of any period, we generallyhave subscription contracts in place for a high percentage of our totalrevenues for the next 12 months. We monitor the contracted revenues fromthese agreements and refer to them as annualized contract value. We define ourannualized contract value as the aggregate value on an annualized basis of allrecurring subscription contracts in effect on a reporting date. Any revenuesassociated with subscription contracts that are entered into during a reportingperiod will be reflected in the annualized contract value beginning at the endof that period. As a result, annualized contract value at the end of any periodis the annualized contract value at the beginning of the period plus theannualized contract revenue associated with new subscription contracts signedduring that period minus the annualized contract revenues associated withsubscription contracts not renewed. Annualized contract value does not includeany fees associated with any non-recurring revenues.

 

Annualized contract value is an importantmetric for our business. However, annualized contract value may differ from ourfuture reported revenues due to a number of factors, which include:

 

·                  newsubscription-based revenues;

 

·                  additionalone-time revenue;

 

·                  changesin the contract value of our subscription contracts;

 

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·                  cancellationsand non-renewals of subscription contracts; and

 

·                  revenuerecognition timing differences due to the provisions of generally acceptedaccounting principles in the United States (“ U.S. GAAP”).

 

Our annualized contract value for theRiskMetrics business and ISS business as of March 31, 2009, December 31,2008, and March 31, 2008, as well as the percentage growth period overperiod is set forth, separately for each business, in the tables below.

 

**Year-Over-Year Comparison**

 
| ** **                                      | ** ** | **As of March 31,** | ** ** |
|-------------------------------------------------|------------|------------------------------------|------------|
| ** **                                      | ** ** | **2009**                           | ** ** | **2008** | ** ** |
| RiskMetrics business annualized contract  value |       | $                                  | 159,994    |   | $ | 142,505 |   |
| Percent growth                                  |       | 12.3                               | *%*        | * * | * * |
| ISS business annualized contract value (1)      |       | $                                  | 127,977    |   | $ | 125,059 |   |
| Percent growth                                  |       | 2.3                                | *%*        | * * | * * |

 

**Sequential Comparison**

 
| ** **                                      | ** ** | **As of March 31, 2009** | ** ** | **As of December  31, 2008** | ** ** |
|-------------------------------------------------|------------|----------------------------------------------|------------|---------------------------------------------|------------|
| RiskMetrics business  annualized contract value |       | $                                            | 159,994    |                                        | $          | 160,200 |   |
| Percent growth (decline)                        | * *   | *(0.1*                                       | *)%*       | * *                                    | * *   |
| ISS business annualized contract value (1)      |       | $                                            | 127,977    |                                        | $          | 125,797 |   |
| Percent growth                                  | * *   | *1.7*                                        | *%*        | * *                                    | * *   |

 

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(1)  Innovest was acquired on March 2,2009 with $5.2 million of ACV, which is not included in ISS ACV as of December 31,2008 and March 31, 2008.  InnovestACV does not include any contracts where fees are based on the clients’ AUM,which currently have approximately $0.8 million of annual revenue.

 

The increase in consolidated ACV was drivenby 2008 new Risk sales in both the alternative investment and asset managementsegments in the Americas and EMEA. Consolidated ACV of $288.0 million as of March 31,2009 increased $2.0 million compared to December 31, 2008 due to theacquisition of Innovest and first quarter 2009 new sales being offset bynon-renewals as well as the currency depreciation of the Euro and Britishpound.

 

*Renewal Rate*

 

Because non-renewals of subscriptioncontracts decrease our annualized contract value, which in turn decreases ourrevenues, a key operating metric is renewal rate. Our renewal rate for anyperiod is defined as the amount of annualized contract value that renews in aperiod divided by the amount of annualized contract value with an expirationdate during that period. If a client has a higher contract value upon renewalof its existing contract, the amount in excess of the prior period’s contractis considered new contract revenue for purposes of this calculation.

 

The renewal rate for our RiskMetrics businessand ISS business for the three months ended March 31, 2009 and 2008 is setforth separately for each business in the table below.

 
| ** **                        | ** ** | **Three Months Ended  March 31,** | ** ** |
|-----------------------------------|------------|--------------------------------------------------|------------|
| ** **                        | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
| RiskMetrics business renewal rate |       | 85.8                                             | %          | 87.7 | % |
| ISS business renewal rate         |       | 80.4                                             | %          | 89.6 | % |

 

*Non-Recurring Revenues*

 

Non-recurring revenues result from sales on anon-subscription basis. Non-recurring revenues for the RiskMetrics business andISS business for the three months ended March 31, 2009 and 2008 are setforth in the table below. Our

 

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non-subscription services include AUM fees, implementation,compensation advisory services and similar services and overages related to ISS’Proxy Research and Voting business. Revenues from implementation and AUM arerecognized as the related subscription service is provided, some CompensationAdvisory Services revenues are recognized over a three month period and othernon-recurring revenues are recognized once the service is provided. To theextent that clients’ actual usage of proxy voting services or proxy researchreports exceeds contracted-for limits, the excess usage is considered to be anoverage and clients are charged additional fees. Our clients’ overages aretypically an indication of larger proxy voting contract renewals.

 
| ** **                                          | ** ** | **Three Months Ended  March 31,** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                          | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
| RiskMetrics business percent non-recurring  revenue |       | 1.5                                              | %          | 1.0 | % |
| ISS business percent non-recurring revenue          |       | 16.3                                             | %          | 15.4 | % |

 

***Operating Costs andExpenses***

 

Compensation expense represents a substantialmajority of our expenses across all of our operating functions. Compensationexpenses before stock-based compensation expense are comprised of base salary,bonuses, benefits, payroll taxes and sales commissions. While we expect to growour headcount over time to take advantage of our market opportunity, we believethat the economies of scale in our operating model will allow us to grow ourcompensation expenses at a lower rate than revenues.

 

Other significant operating expenses aredata, proxy voting fees, occupancy and telecommunications and web hostingcosts. Since we deliver our products and services using a common data andtechnology infrastructure, we expect these expenses generally to increase atless than the rate of revenue growth. Overall, our goal is to keep the rate ofgrowth of these operating expenses below the rate of growth of our revenues.However, in order to take advantage of growth opportunities, we may invest inour business in order to support increased revenue growth. This might result invariability in our operating margin in the short term.

 

We allocate compensation expenses, includingstock-based compensation expense, to our cost of revenues, sales and marketing,research and development and general and administrative expense categoriesbased on the actual costs associated with each employee. Other costs associatedwith the employees, such as occupancy, travel and telecommunications, areincluded in the same cost categories as the corresponding employees. Weallocate shared services to each segment based on usage or headcount. Thefollowing summarizes our significant operating expenses:

 

*Costs of Revenues*

 

Costs of revenues include costs related toproduction of proxy research and voting, web hosting, data, account management,implementation and systems operations and allowances for doubtful accounts.Costs in this area consist primarily of staff compensation and related costsand payments to third party vendors, including third party web hosting and dataproviders.

 

*Research and Development*

 

Research and development expenses includecosts related to product development, research technology, application design,technology infrastructure and analytics development. Costs in this area consistprimarily of staff compensation costs and related expenses and consultantexpenses.

 

*Selling and Marketing*

 

Selling and marketing expenses consist ofcosts related to our sales force, product management and marketingprofessionals. These costs include staff compensation costs and relatedexpenses, including commissions and general marketing costs.

 

*General and Administrative*

 

General and administrative expenses consistof expenses for finance, legal, accounting, human resources and informationtechnology personnel. Costs in this area primarily consist of staffcompensation and related expenses, legal costs, insurance costs, accountingfees and other professional services fees.

 

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*Depreciation and Amortization of Property andEquipment*

 

Depreciation and amortization of property andequipment includes depreciation of software, computer and related equipment,furniture and fixtures and telecommunications equipment, which is recorded overthe respective useful lives of the related assets. Depreciation also includesthe amortization of leasehold improvements which are amortized over the shorterof the term of the lease or the assets’ useful life, and the amortization ofcapitalized software costs. Amortization expenses for leasehold improvementsand capitalized software development costs are included in depreciation andamortization of property and equipment in the statement of operations.

 

*Amortization of Intangible Assets*

 

Amortization expense includes the amortizationof finite life intangible assets such as acquired technology, customerrelationships, trade names, license agreements, proprietary process andnon-compete agreements, which are amortized over their estimated useful lives.

 

***Adjusted EBITDA***

 

The Adjusted EBITDA data below sets forthsupplementary information that we believe is useful for investors in evaluatingour underlying operations:

 
| ** **      | ** ** | **Three months ended** | ** ** | ** **                 | ** ** |
|-----------------|------------|----------------------------------|------------|----------------------------|------------|
| ** **      | ** ** | **March 31,**               | ** ** | **% Growth for** | ** ** |
| ** **      | ** ** | **2009**                         | ** ** | **2008**                   | ** ** | **three months** | ** ** |
|            |       |                             |       |                       |       |   |   |
| Adjusted EBITDA |       | $                                | 29,359     |                       | $          | 23,203 |   | 26.5 | % |
|                 |            |                                  |            |                            |            |  |  |  |  |

 

Adjusted EBITDA, as defined in our credit facilities, represents netincome (loss) before interest expense, interest income, other income (expense),income tax expense (benefit), depreciation and amortization of property and equipment,amortization of intangible assets, non-cash stock-based compensation expenseand extraordinary or non-recurring charges or expenses. It is a material metricused by our lenders in evaluating compliance with the maximum consolidatedleverage ratio covenant in our credit facilities. The maximum consolidatedleverage ratio covenant, as defined in our credit facilities, represents theratio of total indebtedness as compared to Adjusted EBITDA, and can not exceeda maximum ratio range which declines from 8.50 to 3.00 over the life of thecredit facilities. Non-compliance with this covenant could result in us beingrequired to immediately repay our outstanding indebtedness under our creditfacilities. Adjusted EBITDA is also a metric used by management to measureoperating performance and for planning, including preparation of annualbudgets, analyzing investment decisions and evaluating profitability.

 

We also present Adjusted EBITDA as a supplemental performance measurebecause we believe that this measure provides our board of directors,management and investors with additional information to measure ourperformance, provide comparisons from period to period by excluding potentialdifferences caused by variations in capital structure (affecting interest expense),tax position (such as the impact on periods of changes in effective tax ratesor net operating losses), the age and book depreciation of fixed assets(affecting relative depreciation expense), acquisitions (affecting amortizationexpense) and compensation plans (affecting stock-based compensation expense).

 

Adjusted EBITDA is not a measurement of our financial performance underU.S. GAAP and should not be considered as an alternative to net income,operating income or any other performance measures derived in accordance withU.S. GAAP or as an alternative to cash flow from operating activities as ameasure of our profitability or liquidity.

 

We understand that, although Adjusted EBITDA is frequently used bysecurities analysts, lenders and others in their evaluation of companies,Adjusted EBITDA has limitations as an analytical tool, and you should notconsider it in isolation, or as a substitute for an analysis of our results asreported under U.S. GAAP. Some of these limitations are:

 

·                                          Adjusted EBITDA does not reflect our cashexpenditures, or future requirements for capital expenditures or contractualcommitments;

 

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·                                          Adjusted EBITDA does not include stock basedcompensation expense;

 

·                                          Adjusted EBITDA does not reflect changes in,or cash requirements for, our working capital needs;

 

·                                          Adjusted EBITDA does not reflect thesignificant interest expense, or the cash requirements necessary to serviceinterest or principal payments on our indebtedness;

 

·                                          Although depreciation and amortization arenon-cash charges, the assets being depreciated and amortized often will have tobe replaced in the future, and Adjusted EBITDA does not reflect any cashrequirements for such replacements; and

 

·                                          Other companies in our industry may calculateAdjusted EBITDA differently than we do, limiting its usefulness as acomparative measure.

 

The table below sets forth areconciliation of net income to Adjusted EBITDA on our historical results:

 
| ** **                                               | ** ** | **Three months ended  March 31,** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                               | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
| Net income                                               |       | $                                                | 8,527      |   | $ | 347 |   |
| Interest, other income (expense), net                    |       | 5,193                                            |       | 11,477 |   |
| Income tax expense                                       |       | 4,981                                            |       | 227 |   |
| Depreciation and amortization of property  and equipment |       | 1,955                                            |       | 2,115 |   |
| Amortization of intangible assets                        |       | 5,592                                            |       | 5,456 |   |
| Stock-based compensation                                 |       | 1,808                                            |       | 3,361 |   |
| Non-recurring expenses (a)                               |       | 1,303                                            |       | 198 |   |
| Loss on disposal of property and equipment               |       | —                                           |       | 22 |   |
| Adjusted EBITDA                                          |       | $                                                | 29,359     |   | $ | 23,203 |   |

 

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(a)  Represents employee severance costs, acquisition costs, andlease exit costs.

 

**Critical Accounting Policies and Estimates**

 

Ourcondensed consolidated financial statements are prepared in conformity with USGAAP. Our critical accounting policies, including the assumptions and judgmentsunderlying them, require the application of significant judgment in thepreparation of our financial statements, and as a result they are subject to agreater degree of uncertainty. In applying these policies, we use our judgmentto determine the appropriate assumptions to be used in calculating estimatesthat affect the reported amounts of assets, liabilities, revenues and expenses.Estimates and assumptions are based on historical experience and on variousother factors that are believed to be reasonable under the circumstances.Accordingly, actual results could differ from those estimates. Significantestimates and assumptions made by management include the deferral and recognitionof revenue, impairment of goodwill and intangible assets, the fair value ofacquired assets and liabilities, stock-based compensation, gains or losses onderivative instruments, accounting for income taxes and other matters thataffect the condensed consolidated financial statements and relateddisclosures.  There have been no changes to our significant accountingpolicies since December 31, 2008 except as discussed below in Effects ofRecently Issued Accounting Pronouncements.

 

**Results of Operations**

 

*Segments and Periods Presented*

 

We currently operate in two segments, the “RiskMetricsbusiness” and the “ISS business.”

 

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*Factors Affecting the Comparability of Results*

 

The results of Innovest are not included inour results of operations until the acquisition date of March 2, 2009.Innovest supplements the ISS business to support its Financial Research andAnalysis product and services offerings.

 

On January 25, 2008, we completed an initial public offeringof 16,100,000 shares of common stock, which included 4,035,816 shares sold byselling stockholders and 2,100,000 shares to cover over-allotments, which wasexercised in full in January 2008. We received net proceeds of $193.9 million from the offering. We did notreceive any proceeds from the sale of the shares by the selling stockholders.  As such, weighted average commonshares outstanding for the three months ended March 31, 2008 only includesthe 12,100,000 additional shares sold in the initial public offering for aportion of that period. In addition, immediately prior to the completionof our initial public offering we granted each of our full-time employees anoption to acquire 500 shares of our common stock, at an exercise price equal tothe initial public offering price. Such grant resulted in stock-basedcompensation of $129 and $1,357 being recorded for the three months ended March 31,2009 and 2008, respectively.

 

In January 2008, we utilized a portion of proceeds from theinitial public offering to prepay the entire outstanding indebtedness under thesecond lien loan, in the amount of $125.0 million. As a result of theprepayment we incurred $5.0 million in expenses during the three months ended March 31,2008, which were comprised of a $1.25 million debt prepayment penalty fee,a $2.4 million write-off of debt issuance costs and a $1.4 million loss onan interest rate swap settlement. Such costs have been included in interest,dividend, investment and other income (expense), net in the statement ofoperations for the three months ended March 31, 2008.

 

*Three months ended March 31, 2009compared to the three months ended March 31, 2008*

 

The following tables provide information with respect to ourconsolidated and segment operating results:

 

**Consolidated RiskMetrics Group, Inc.**

 
| ** **                                                      | ** ** | **Three months ended  March 31,**                   | ** ** | **Increase (decrease)** | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                      | ** ** | **2009**                                                           | ** ** | **2008**                     | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                                      | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Revenues                                                        |       | $                                                                  | 77,381     |                         | $          | 71,220 |   | $ | 6,161 |   | 8.7 | % |
| Operating costs and expenses:                                   |       |                                                               |       |                         |       |   |   |   |   |
| Cost of revenues                                                |       | 23,322                                                             |       | 22,704                       |       | 618 |   | 2.7 | % |
| Research and development                                        |       | 10,137                                                             |       | 10,461                       |       | (324 | ) | (3.1 | )% |
| Selling and marketing                                           |       | 7,067                                                              |       | 9,206                        |       | (2,139 | ) | (23.2 | )% |
| General and administrative                                      |       | 10,607                                                             |       | 9,205                        |       | 1,402 |   | 15.2 | % |
| Depreciation and amortization of property  and equipment        |       | 1,955                                                              |       | 2,115                        |       | (160 | ) | (7.6 | )% |
| Amortization of intangible assets                               |       | 5,592                                                              |       | 5,456                        |       | 136 |   | 2.5 | % |
| Loss on disposal of fixed assets                                |       | —                                                             |       | 22                           |       | (22 | ) | (100 | )% |
| Total operating costs and expenses(1)                           |       | 58,680                                                             |       | 59,169                       |       | (489 | ) | (0.8 | )% |
| Income from operations                                          |       | 18,701                                                             |       | 12,051                       |       | 6,650 |   | 55.2 | % |
| Interest, dividend, investment and other  income (expense), net |       | (5,193                                                             | )          | (11,477                      | )          | (6,284 | ) | (54.8 | )% |
| Income before provision for income taxes                        |       | 13,508                                                             |       | 574                          |       | 12,934 |   | * | % |
| Provision for income taxes                                      |       | 4,981                                                              |       | 227                          |       | 4,754 |   | * | % |
| Net income                                                      |       | $                                                                  | 8,527      |                         | $          | 347 |   | $ | 8,180 |   | * | % |

 

----

* Exceeds 100%

 

(1) Includes stock-based compensation expense of $1,808 and $3,361for the three months ended March 31, 2009 and 2008, respectively.

 

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**RiskMetrics Business**

 
| ** **                                               | ** ** | **Three months ended  March 31,**                   | ** ** | **Increase (decrease)** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                               | ** ** | **2009**                                                           | ** ** | **2008**                     | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                               | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Revenues                                                 |       | $                                                                  | 40,194     |                         | $          | 34,436 |   | $ | 5,758 |   | 16.7 | % |
| Operating costs and expenses:                            |       |                                                               |       |                         |       |   |   |   |   |
| Cost of revenues                                         |       | 8,054                                                              |       | 8,133                        |       | (79 | ) | (0.9 | )% |
| Research and development                                 |       | 7,201                                                              |       | 7,079                        |       | 122 |   | 1.7 | % |
| Selling and marketing                                    |       | 3,648                                                              |       | 4,330                        |       | (682 | ) | (15.7 | )% |
| General and administrative                               |       | 4,921                                                              |       | 4,438                        |       | 483 |   | 10.9 | % |
| Depreciation and amortization of property  and equipment |       | 1,086                                                              |       | 1,160                        |       | (74 | ) | (6.4 | )% |
| Amortization of intangible assets                        |       | 75                                                                 |       | —                       |       | 75 |   | — | % |
| Loss (gain) on disposal of fixed assets                  |       | —                                                             |       | 9                            |       | (9 | ) | — | % |
| Total operating costs and expenses(2)                    |       | 24,985                                                             |       | 25,149                       |       | (164 | ) | (0.1 | )% |
| Income from operations                                   |       | $                                                                  | 15,209     |                         | $          | 9,287 |   | $ | 5,922 |   | 63.8 | % |

 

----

(2) Includes stock-based compensation expense of $785 and $1,338for the three months ended March 31, 2009 and 2008, respectively.

 

**ISS Business**

 
| ** **                                               | ** ** | **Three months ended  March 31,**                   | ** ** | **Increase (decrease)** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                               | ** ** | **2009**                                                           | ** ** | **2008**                     | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                               | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Revenues                                                 |       | $                                                                  | 37,187     |                         | $          | 36,784 |   | $ | 403 |   | 1.1 | % |
| Operating costs and expenses:                            |       |                                                               |       |                         |       |   |   |   |   |
| Cost of revenues                                         |       | 15,268                                                             |       | 14,571                       |       | 697 |   | 4.8 | % |
| Research and development                                 |       | 2,936                                                              |       | 3,382                        |       | (446 | ) | (13.2 | )% |
| Selling and marketing                                    |       | 3,419                                                              |       | 4,876                        |       | (1,457 | ) | (29.9 | )% |
| General and administrative                               |       | 5,686                                                              |       | 4,767                        |       | 919 |   | 19.3 | % |
| Depreciation and amortization of property  and equipment |       | 869                                                                |       | 955                          |       | (86 | ) | (9.0 | )% |
| Amortization of intangible assets.                       |       | 5,517                                                              |       | 5,456                        |       | 61 |   | 1.1 | % |
| Loss on disposal of fixed assets                         |       | —                                                             |       | 13                           |       | (13 | ) | (100.0 | )% |
| Total operating costs and expenses(3)                    |       | 33,695                                                             |       | 34,020                       |       | (325 | ) | (1.0 | )% |
| Income from operations                                   |       | $                                                                  | 3,492      |                         | $          | 2,764 |   | $ | 728 |   | 26.3 | % |

 

----

(3) Includes stock-based compensation expense of $1,023 and $2,023the three months ended March 31, 2009 and 2008, respectively.

 

The following tables provide information with respect to ourconsolidated and segment revenues in certain geographic regions:

 

**Consolidated RiskMetrics Group, Inc.**

 
| ** **                            | ** ** | **Three months ended  March 31, 2009**         | ** ** | **Three months ended  March 31, 2008** | ** ** | **Increase (decrease)** | ** ** |
|---------------------------------------|------------|--------------------------------------------------------------------|------------|------------------------------------------------------------|------------|------------------------------|------------|
| **Region**                            | ** ** | **Revenue**                                                        | ** ** | **% of  Total  Revenue**                              | ** ** | **Revenue**                  | ** ** | **% of  Total  Revenue** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                            | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Americas                              |       | $                                                                  | 46,871     |                                                       | 60.6       | %                            | $          | 44,630 |   | 62.7 | % | $ | 2,241 |   | 5.0 | % |
| Europe, Middle East and Africa (EMEA) |       | 26,339                                                             |       | 34.0                                                       | %          | 22,386                       |       | 31.4 | % | 3,953 |   | 17.7 | % |
| Asia                                  |       | 4,171                                                              |       | 5.4                                                        | %          | 4,204                        |       | 5.9 | % | (33 | ) | (0.8 | )% |
| Total                                 |       | $                                                                  | 77,381     |                                                       | 100.0      | %                            | $          | 71,220 |   | 100.0 | % | $ | 6,161 |   | 8.7 | % |

 

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**RiskMetrics Business**

 
| ** **                            | ** ** | **Three months ended  March 31, 2009**         | ** ** | **Three months ended  March 31, 2008** | ** ** | **Increase (decrease)** | ** ** |
|---------------------------------------|------------|--------------------------------------------------------------------|------------|------------------------------------------------------------|------------|------------------------------|------------|
| **Region**                            | ** ** | **Revenue**                                                        | ** ** | **% of  Total  Revenue**                              | ** ** | **Revenue**                  | ** ** | **% of  Total  Revenue** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                            | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Americas                              |       | $                                                                  | 18,270     |                                                       | 45.5       | %                            | $          | 15,534 |   | 45.1 | % | $ | 2,736 |   | 17.6 | % |
| Europe, Middle East and Africa (EMEA) |       | 19,248                                                             |       | 47.9                                                       | %          | 16,275                       |       | 47.3 | % | 2,973 |   | 18.3 | % |
| Asia                                  |       | 2,676                                                              |       | 6.6                                                        | %          | 2,627                        |       | 7.6 | % | 49 |   | 1.9 | % |
| Total                                 |       | $                                                                  | 40,194     |                                                       | 100.0      | %                            | $          | 34,436 |   | 100.0 | % | $ | 5,758 |   | 16.7 | % |

 

**ISSBusiness**

 
| ** **                            | ** ** | **Three months ended  March 31, 2009**         | ** ** | **Three months ended  March 31, 2008** | ** ** | **Increase (decrease)** | ** ** |
|---------------------------------------|------------|--------------------------------------------------------------------|------------|------------------------------------------------------------|------------|------------------------------|------------|
| ** **                            | ** ** | ** **                                                         | ** ** | **% of Total**                                   | ** ** | ** **                   | ** ** | **% of Total** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Region**                            | ** ** | **Revenue**                                                        | ** ** | **Revenue**                                                | ** ** | **Revenue**                  | ** ** | **Revenue** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                            | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Americas                              |       | $                                                                  | 28,601     |                                                       | 76.9       | %                            | $          | 29,097 |   | 79.1 | % | $ | (496 | ) | (1.7 | )% |
| Europe, Middle East and Africa (EMEA) |       | 7,091                                                              |       | 19.1                                                       | %          | 6,110                        |       | 16.6 | % | 981 |   | 16.1 | % |
| Asia                                  |       | 1,495                                                              |       | 4.0                                                        | %          | 1,577                        |       | 4.3 | % | (82 | ) | (5.2 | )% |
| Total                                 |       | $                                                                  | 37,187     |                                                       | 100.0      | %                            | $          | 36,784 |   | 100.0 | % | $ | 403 |   | 1.1 | % |

 

Set forth below is a discussion of ourresults for the three months ended March 31, 2009 compared to the threemonths ended March 31, 2008.

 

*Revenues.* Consolidated revenues for the threemonths ended March 31, 2009 increased by $6.2 million, or 8.7%, to $77.4million from $71.2 million. Revenuegrowth was driven by a 16.7%increase in the RiskMetrics business and 1.1% increase in the ISS business.  Revenue for the three monthsended March 31, 2009 includes $0.6 million of revenue from Innovest, whichwas acquired on March 2, 2009.

 

RiskMetrics revenues for the three monthsended March 31, 2009 increased by $5.8 million, or 16.7%, to $40.2 millionfrom $34.4 million.  The $5.8 millionincrease in revenues was primarily due to a $4.6 million, or 15.2%, increase inrevenues from our Market Risk products. The increase in revenues from Market Risk Products was due to a 16.2%increase in revenues from RiskManager due to strong 2008 sales of RiskManagerto asset managers and hedge funds as they increased their outsourcing of riskreporting services partially offset by increased non-renewals.  Revenue growth was also driven by a 17.6%increase in the Americas region and an 18.3% increase in the EMEA region drivenby strong sales of RiskManager in these regions due to, among other things,increased investor demand and the need for financial services firms to complywith regulatory requirements.

 

ISS revenues forthe three months ended March 31, 2009 increased by 1.1%, to $37.2 millionfrom $36.8 million.  The increase inrevenues was primarily due to increased ES&G revenue, including Innovest,and increased demand for proxy research and SCAS products partially offset by adecline in CFRA revenues.   Revenues fromour Governance Services products increased 3.1% to $23.1 million from $22.4million primarily due to increased revenue in proxy research services and SCAS.Governance services revenue accounted for 62.2% of total revenue for the threemonths ended March 31, 2009 compared to 60.9% in the prior year.  Revenue from our Financial Research andAnalysis products and services decreased 2.2% to $14.1 million from $14.4million due to a decline in CFRA revenue as a result of declining renewal ratespartially offset by increased ES&G revenue, including revenues produced bythe Innovest acquisition.

 

*Operating costs and expenses.* Consolidating operating expenses for the three months ended March 31,2009 decreased by 0.8% to $58.7 million from $59.2 million. As a percentage of revenues, operating expenses decreased to 75.8% from83.1% due to increased monitoring of costs, including headcount, while gainingeconomies of scale for increased revenue.   The $0.5 million declinein operating expenses was primarily due to the following:

 

·                  $1.6million decline in stock based compensation primarily due to the Company’s IPOstock option grant in January 2008.

·                  $0.8million decrease in travel and entertainment due to lower travel and increasedcost control.

·                  $0.4million decrease in HR costs due to lower recruiting fees.

·                  $0.4million decline in marketing expenses.

 

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·                  $0.5million decline in data costs due primarily to a one-time $0.8 million expensereduction for the settlement of a data vendor liability for less than theamounts previously accrued.

·                  Changes in foreign exchange rates(principally the strengthening of the US dollar) in 2009 compared to 2008 had afavorable impact on reported operating expenses.

 

Theabove declines were partially offset by:

 

·                  $1.3million in one-time expenses during the three months ended March 31, 2009which consisted of $0.6 million in lease exit costs, $0.5 million of employeeseverance and $0.2 million of Innovest acquisition costs.

·                  $0.8million increase in technology costs due to higher web hosting and maintenancecosts.

·                  $0.5million increase in compensation due to increased salaries partially offset bya decline in commissions as a result of a decline in new sales.

·                  Increasedforeign currency transaction losses.

 

RiskMetrics operating expenses for the threemonths ended March 31, 2009 of $25.0 million decreased $0.2 millioncompared to prior year. As a percentage of revenues, operating expensesdecreased to 62.2% from 73.0% due to revenue growth of 16.7% and expensesremaining approximately the same as compared to the prior year.

 

ISS operating expenses for the three monthsended March 31, 2009 decreased 1.0% to $33.7 million from $34.0million.  The decrease in operatingexpenses was primarily due to a decrease in stock based compensation, HR costsand marketing costs partially offset by an increase in one-time costs.  As a percentage of revenues, operating expensesdecreased to 90.6% from 92.5%.

 

*Cost of revenues.*  Consolidated cost of revenues for the threemonths ended March 31, 2009 increased to $23.3 million, or 2.7% from$22.7 million. The increase in cost of revenues resulted primarily fromincreased foreign currency transaction losses of $1.3 million due to theweakening Euro and British pound, increased technology costs of $0.6 million asa result of increased web hosting costs partially offset by a $0.9 milliondecline in stock based compensation.  Asa percentage of revenues, cost of revenues decreased to 30.1% from 31.9%.

 

RiskMetrics cost of revenues for the threemonths ended March 31, 2009 of $8.1 million were essentially the same ascompared to the prior year due to an increase in foreign currency transactionlosses offset by a decline in data costs resulting from a one-time $0.8 milliondata accrual reduction.  As a percentageof revenues, Risk cost of revenues decreased to 20.0% from 23.6%.

 

ISS cost ofrevenues for the three months ended March 31, 2009 increased to $15.3million, or 4.8% from $14.6 million. The increase was primarily due toincreased compensation costs and foreign currency losses partially offset by adecline in stock-based compensation expense. As a percentage of revenues, ISS cost of revenues increased to 41.1%from 39.6% due to increased foreign currency losses of $0.5 million.

 

*Research and development expenses.*  Consolidated research and developmentexpenses for the three months ended March 31, 2009 decreased to $10.1 million,or 3.1% from $10.5 million. As a percentage of revenues, research anddevelopment expenses decreased to 13.1% from 14.7% primarily due to a declinein stock-based compensation of $0.4 million.

 

RiskMetrics research and development expensesfor the three months ended March 31, 2009 increased to $7.2 million, or1.7% from $7.1 million. The increase was primarily due to increasedcompensation costs of $0.8 million, partially offset by a decline in stockbased compensation and travel and entertainment.

 

ISS research anddevelopment expenses for the three months ended March 31, 2009 decreasedto $2.9 million from $3.4 million.  Thedecrease was primarily due to a decline in compensation costs of $0.5 million,partially offset by increased technology costs.

 

*Selling and marketing expenses.*  Consolidated selling and marketing expensesfor the three months ended March 31, 2009 decreased to $7.1 million, or23.2% from $9.2 million. As a percentage of revenues, selling and marketingexpenses decreased to 9.1% from 12.9% due to a decline in compensation costsand lower marketing expenses.

 

RiskMetrics selling and marketing expensesfor the three months ended March 31, 2009 decreased to $3.6 million, or15.7% from $4.3 million. The decrease was primarily due to a decrease incompensation of $0.8 million as a result a decline in commission due to lowernew sales.

 

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ISS selling andmarketing expenses for the three months ended March 31, 2009 decreased to$3.4 million, or 29.9% from $4.9 million. The decrease was primarily due to a$1.0 million decline in compensation costs as well as a decline in marketingand travel and entertainment expenses.

 

*General and administrative expenses*.  Consolidated general and administrativeexpenses for the three months ended March 31, 2009 increased to $10.6million, or 15.2% from $9.2 million. The $1.4 million increase in general andadministrative costs is primarily due to one-time costs of $1.3 millionincurred during the three months ended March 31, 2009 which is comprisedof $0.6 million in lease exit costs, $0.5 million in employee severance and$0.2 million in Innovest acquisition costs. As a percentage of revenues, general and administrative expensesincreased to 13.7% from 12.9%.

 

RiskMetrics general and administrativeexpenses for the three months ended March 31, 2009 increased to $4.9million, or 10.9% from $4.4 million. The increase was primarily due toincreased compensation costs, accounting, insurance and consulting costs as aresult of being a public company, partially offset by a decline in stock basedcompensation expense of $0.2 million.

 

ISS general andadministrative expenses for the three months ended March 31, 2009increased to $5.7 million, or 19.3% from $4.8 million. The increase wasprimarily due to $1.3 million of one-time costs discussed above, partiallyoffset by a decline in recruiting costs.

 

*Depreciation and amortization of property andequipment.* Depreciation and amortization of property and equipment for the threemonths ended March 31, 2009 decreased to $2.0 million from $2.1 million.

 

*Amortization of intangible assets.*  Amortization of intangible assets for threemonths ended March 31, 2009 increased to $5.6 million from $5.5 millionprimarily due to the acquisition of Innovest.

 

*Interest, dividend and investment income(expense), net.* Net interest, dividend and investment expense for the three months endedMarch 31, 2009 decreased to $5.2 million from $11.5 million.  This decrease in expense was due to decreasedinterest expense (net of amortization) as a result of reduced debt borrowingsand one-time charges incurred in 2008. In January 2008, we utilized a portion of proceeds from the initialpublic offering to prepay the entire outstanding indebtedness under the secondlien loan, in the amount of $125.0 million. As a result of the prepaymentwe incurred $5.0 million in expenses during the three months ended March 31,2008, which were comprised of a $1.25 million debt prepayment penalty fee,a $2.4 million write-off of debt issuance costs and a $1.4 million loss onan interest rate swap settlement.

 

*Provision for income taxes. *The provision forincome taxes represents an effective tax rate of 36.9% for the three monthsended March 31, 2009 as compared to an effective rate of 39.5% for thecomparable prior year period.  Theeffective rate declined primarily due to an increase in pre-tax income and adecline in non-deductible stock-based compensation expense. In addition,effective tax rates are subject to change based on the taxable income in allthe jurisdictions in which we do business.

 

**Liquidity and Capital Resources**

 

At March 31, 2009, we had cash and cashequivalents of $159.3 million.  Webelieve our existing cash and cash equivalents, our cash flow from operatingactivities and borrowing capacity under our existing credit facilities will besufficient to meet our anticipated cash needs for at least the next 12 months,during which time we expect to make approximately $10.0 million to$11.0 million of capital expenditures. Our future working capitalrequirements will depend on many factors, including our revenue growth, debtservice, future acquisitions of businesses and investments in our own business.To the extent our liquidity sources are insufficient to fund our futureactivities we may need to raise additional funding through a public or privateequity or debt offering. No assurances can be given that additional financingwill be available in the future or that if available, such financing will be onfavorable terms.

 

*Cash Flows*

 

Our cash flow tends to be lower in thebeginning of each year due to bonuses and commissions paid during this period.As a result, we typically generate more cash flows from operations during thesecond half of the year than during the first half of the year.

 

Cash flows from operating activitiesincreased by $17.2 million in the three months ended March 31, 2009compared to 2008 due to increased net income and increased contribution fromworking capital.   Operating activities for the threemonths ended March 31, 2009 provided cash of $4.3 million primarily reflecting net income of $8.5 million, plus $7.5 

 

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millionin depreciation and amortization, $1.8 million in stock based compensation anda $4.9 million netincrease from taxes partially offset by a $20.4 million decline in accruedexpenses due to the payment of bonuses.  Cash used in operations of $12.9 for the three months ended March 31,2008 was negatively impacted by $1.3 million of cash used for a debtpre-payment penalty fee and $1.4 million for an interest rate swap settlementin connection with the pre-payment of debt in 2008.

 

Investing activities for the three monthsended March 31, 2009 used cash of $15.5 million due to the acquisition ofInnovest for $14.9 million and $0.6 million for capital expenditures.  Investing activities for the three monthsended March 31, 2008 used cash of $1.8 million for capital expenditures.

 

Financing activities for the three monthsended March 31, 2009 provided cash of $0.5 million from the exercise ofstock options and related tax benefits. Financing activities for the threemonths ended March 31, 2008 provided cash of $74.7 million as a result of$197.4 million raised from our initial public offering and $2.7million from stock option proceeds, partially offset by $125.8 million in debtpayments.

 

*Long Term Debt*

 

The Company’s debt is comprised of two termloan facilities and a $25 million revolving credit facility.  As of March 31, 2009 $290.6 million ofdebt remains outstanding under the first lien loan and no indebtedness remainoutstanding under the second lien term loan or revolving credit facility.  The maturity date of the first lien term loanis December 2013. The next principal debt payment of $0.7 million is dueon June 30, 2009.  The terms of theindebtedness include various covenant compliance requirements, includingmaintaining certain Adjusted EBITDA earning levels, as defined in our creditfacilities. The Company has pledged all of its assets as collateral against thedebt. Amounts paid under the term loans may not be re-borrowed.

 

In February 2007, we entered into twointerest-rate swap agreements to reduce interest rate risks and to manageinterest expense. By entering into these agreements, we change thefixed/variable interest-rate mix of our debt portfolio. As of March 31,2009, the interest rate swaps had notional amounts totaling $253.1 million anda fair value liability totaling $20.8 million. The agreements effectively convert our floating-rate debt intofixed-rate debt. This reduces our risk of incurring higher interest costs inperiods of rising interest rates and increases our risk of paying higherinterest costs in periods of decreasing interest rates. Our interest-rate swapagreements hedge a significant portion of the interest rate risk exposure underour indebtedness. The interest rate swap agreements increased our weightedaverage effective interest rate on the first lien term loan facility to 7.1%during the three months ended March 31, 2009.

 

As of March 31, 2009, we were incompliance with our credit agreements, and we are not aware of any futureevents or transactions that will impact such compliance.

 

*Commitments*

 

In addition to the indebtedness discussedabove, we enter into routine operating lease obligations for our facilities andpurchase obligations to operate our business. Our contractual commitments,including those related to our indebtedness, were comprised of the following asof March 31, 2009:

 
| ** **                            | ** ** | **Payments Due by Period** | ** ** |
|---------------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligation**       | ** ** | **Total**                                 | ** ** | **Within 1 year** | ** ** | **1-3 years** | ** ** | **4-5 years** | ** ** | **After 5 years** | ** ** |
| Debt, including estimated interest    |       | $                                         | 391,399    |   | $ | 23,541 |   | $ | 46,453 |   | $ | 321,405 |   | $ | — |   |
| Interest rate swaps                   |       | 20,758                                    |       | 9,979 |   | 10,779 |   | — |   | — |   |
| Operating leases                      |       | 34,016                                    |       | 7,258 |   | 13,878 |   | 6,469 |   | 6,411 |   |
| Purchase obligation for data          |       | 9,293                                     |       | 7,482 |   | 1,811 |   | — |   | — |   |
| Deferred purchase price obligation(1) |       | 1,165                                     |       | 211 |   | 454 |   | 500 |   | — |   |
| Total (2)                             |       | $                                         | 456,631    |   | $ | 48,471 |   | $ | 73,375 |   | $ | 328,374 |   | $ | 6,411 |   |

 

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(1)           Obligationrelates to prior acquisitions made by ISS.

(2)           Doesnot include $2.1 million of liabilities for uncertain tax liabilities.  The timing of future cash flows associatedwith our liabilities for uncertain tax positions is highly uncertain and we areunable to make reasonably reliable estimates of the period of cash settlementwith the respective taxing authorities.

 

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*Off-Balance Sheet Arrangements*

 

We do not maintain any off-balance sheetarrangements, transactions, obligations or other relationships withunconsolidated entities that would be expected to have a material current orfuture impact upon our financial condition or results of operations.

 

*Impact of Inflation*

 

Our business may be significantly oradversely affected by inflation. Due to the high degree of competition in themarketplace, inflation rate increases might lead to an erosion of our profitmargins.

 

*RelatedParty Transaction*

 

InMay 2008, we entered into a contract for the sale of Market Risk productsto Duff Capital Advisors, which expired on March 31, 2009.  Philip Duff, a director of the Company, isthe founder, CEO and General Partner of Duff Capital Advisors. The contract wasentered into in the normal course of business on terms that we believe areconsistent with (and not preferential to) those provided to our other clients.We recognized $0.2 million in revenue from the Duff Capital Advisors contractfor the three months ended March 31, 2009.

 

**Effects of Recently Issued AccountingPronouncements**

 

On December 4, 2007, FASB issued Statement No. 141(R), *Business Combinations* (SFAS 141(R))and Statement No. 160, *Accounting andReporting of Noncontrolling Interests in Consolidated Financial Statements*,an amendment of ARB No. 51 (SFAS 160). These new standards willsignificantly change the financial accounting and reporting of businesscombination transactions and noncontrolling (or minority) interests inconsolidated financial statements. SFAS 141(R) is required to beadopted concurrently with Statement No. 160 and is effective for businesscombination transactions for which the acquisition date is on or after thebeginning of the first annual reporting period beginning on or after December 15,2008. Application of SFAS 141(R) and SFAS 160 is generallyrequired to be adopted prospectively, except for certain provisions of SFAS 141(R) andSFAS 160, which are required to be adopted retrospectively upon adoption.Business combination transactions accounted for before adoption ofSFAS 141(R) should be accounted for in accordance withSFAS141 and that accounting previously completed under SFAS 141 should notbe modified as of or after the date of adoption of Statement No.141(R).  We adopted SFAS 141R and SFAS 160 effective January 1,2009 and the impact of such adoption will be dependent upon the businesscombinations we pursue.

 

InMarch 2008, the FASB issued SFAS No. 161, “*Disclosures about Derivative Instruments and Hedging Activities, anamendment of FASB**Statement No. 133*”(“SFAS No. 161”). SFAS No. 161 establishes, among other things, thedisclosure requirements for derivative instruments and for hedging activities.We adopted SFAS 161 on January 1, 2009 and have included the requireddisclosures regarding the fair value of derivative instruments in Note 8 to thecondensed consolidated financial statements.

 

InApril 2008, the FASB issued FASB staff position (“FSP”) FAS 142-3, *Determination of the Useful Life of Intangible Assets*(“FSP FAS 142-3”). FSP FAS 142-3 amends the factors an entity should considerin developing renewal or extension assumptions used in determining the usefullife of recognized intangible assets under FASB Statement No. 142, “Goodwilland Other Intangible Assets”. This new guidance applies prospectively tointangible assets that are acquired individually or with a group of otherassets in business combinations and asset acquisitions. We adopted FSP FAS142-3 on January 1, 2009 and such adoption did not have a material impact onthe condensed consolidated financial statements.

 

In April 2009,the FASB issued FSP No. FAS 107-1 and APB 28-1, “Interim Disclosures aboutFair Value of Financial Instruments.” This FSP essentially expands thedisclosure about fair value of financial instruments that were previouslyrequired only annually to also be required for interim period reporting. Inaddition, the FSP requires certain additional disclosures regarding the methodsand significant assumptions used to estimate the fair value of financialinstruments. These additional disclosures will be required beginning with thequarter ending June 30, 2009. We are currently evaluating the requirementsof these additional disclosures.

 

**Item 3.Quantitative and Qualitative Disclosures About Market Risk**

 

Our primary market risk exposure is interestrate risk associated with short and long-term debt bearing variable interestrates. To manage this interest rate risk exposure, we enter into interest rateswap agreements. We are also exposed to foreign currency risk, which canadversely affect our sales and operating profits. The following discussionshould be read in conjunction with Note 8 of our condensed consolidatedfinancial statements appearing elsewhere in this Form 10-Q, which providesfurther information on our derivative instruments.

 

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*Interest Rate Sensitivity*

 

To reduce the exposure associated with our variablerate debt, we entered into two interest-rate swap agreements to reduce interestrate risks and to manage interest expense. By entering into these agreements,we change the fixed/variable interest-rate mix of our debt portfolio. As of March 31,2009, the interest rate swaps had notional amounts totaling $253.1 millionand a fair value liability totaling $20.8 million. The agreementseffectively convert our floating-rate debt into fixed-rate debt. This reducesour risk of incurring higher interest costs in periods of rising interestrates. Our interest-rate swap agreements hedge a substantial majority of theinterest rate risk exposure under our indebtedness. The interest rate swapagreements increased our weighted average effective interest rate on the firstlien term loan facility to 7.1% during the three months ended March 31,2009. A hypothetical, instantaneous increase of one percentage point in theinterest rates applicable to the variable interest rate debt would haveincreased our net interest expense for the three months ended March 31,2009 by approximately $0.7 million.

* *

*Exchange Rate Sensitivity*

 

We have two separate exposures to currencyfluctuation risk—subsidiaries outside the United States which use a foreigncurrency as their functional currency which are translated into U.S. dollarsfor consolidation of assets and liabilities and non-U.S. dollar invoicedrevenues. Changes in foreign exchange rates for our subsidiaries that use aforeign currency as their functional currency are translated into U.S. dollarsand result in cumulative translation adjustments, which are included inaccumulated other comprehensive loss. At March 31, 2009, we hadtranslation exposure to various foreign currencies including the Euro, PoundsSterling, Canadian Dollar, and a limited number of other non-U.S. dollarcurrencies. The net potential loss resulting from a hypothetical 10% adversechange in quoted foreign currency exchange rates partially offset by acorresponding appreciation of the US dollar, as of March 31, 2009, amountsto $3.0 million.

 

We primarily invoice our clients in U.S.dollars; however, we also invoice a portion of our clients in Euro, Sterling,Canadian Dollar, Japanese Yen and a limited number of other non-U.S. dollarcurrencies. As such, the fluctuations in such currencies could impact ouroperating results.

** **

**Item 4. Controlsand Procedures**

 

**(a)****                                 Evaluation ofDisclosure Controls and Procedures**

 

We carried out an evaluation, under thesupervision and with the participation of our management, including our chiefexecutive officer and chief financial officer, of the design and operation ofour disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”) asof March 31, 2009, pursuant to Exchange Act Rule 13a-15. Based uponthat evaluation, the chief executive officer and chief financial officerconcluded that the our disclosure controls and procedures as of March 31,2009 are effective for gathering, analyzing and disclosing the information theCompany is required to disclose in the reports it files under the Exchange Act,within the time periods specified in the Securities and Exchange Commission’s rules andforms.

 

**(b)****                                 Changesin Internal Controls Over Financial Reporting**

 

There were no changes in our internalcontrols over financial reporting during our fiscal quarter ended March 31,2009 that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.

 

**Part II**

 

**Item 1. LegalProceedings**

 

We are not presently involved in any legalproceedings which we believe would have a material adverse effect on ourcondensed consolidated financial statements. However, during the ordinarycourse of business, we are, from time to time, threatened with, or may become aparty to, legal actions and other proceedings.

 

**Item 1A. RiskFactors**

 

There have been no material changes in ourrisk factors from those disclosed in Part 1, Item 1A of our 2008Annual Report on Form 10-K.

 

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**Item 2. UnregisteredSales of Equity Securities and Use of Proceeds**

 

None

 

**Item 3. Defaults UponSenior Securities**

 

None

 

**Item 4. Submission ofMatters to a Vote of Security Holders**

 

None

 

**Item 5. OtherInformation**

 

None.

 

**Item 6. Exhibits**

 
| **Exhibit  Number** | ** ** | **Description**                                                 |
|---------------------|------------|-----------------------------------------------------------------|
| 31.1                |       | Section 302 Certification of Principal  Executive Officer* |
| 31.2                |       | Section 302 Certification of Principal  Financial Officer* |
| 32.1                |       | Section 906 Certification of Principal  Executive Officer* |
| 32.2                |       | Section 906 Certification of Principal  Financial Officer* |

 

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*                                         Filedherewith.

 

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**SIGNATURES**

 

Pursuant to the requirements of Section 13or 15(d) of the Securities Act of 1934, the registrant has duly causedthis report to be signed on its behalf by the undersigned; thereunto dulyauthorized this 5th day of May, 2009.

 
|     | RiskMetrics  Group, Inc. |
|----------|-------------------------------|
|     |                          |
|     | /s/ M. ETHAN  BERMAN          |
|     | M. Ethan  Berman              |
| * * | *Chief Executive Officer*     |

 

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