Tableof Contents

 

 

 

**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 June 30, 2008**

 

**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, 44th 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 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 o         |
|-----------------------------------------------|--------|----------------------------------|
|                                          |   |                             |
| Non-accelerated filer x                       |   | 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 August 6th, 2008 was:

 

| **Class**                   | ** ** | **Outstanding** |
|-----------------------------|------------|-----------------|
| Common stock $.01 par value |       | 60,557,255      |

 

 

 

----

Tableof Contents

 

**RiskMetricsGroup**

**Indexto Form 10-Q**

 

**Table of Contents**

 
| ** **                                                                                                     | ** **                                                                                                                                                                        | ** ** | **Page Number** |
|----------------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------|
| **PART I – FINANCIAL INFORMATION**                                                                   | ** **                                                                                                                                                                        |       |
| Item 1 —  Financial Statements                                                                       | ** **                                                                                                                                                                        |       |
| ** **                                                                                                     | Condensed Consolidated Financial Statements as of December 31,  2007 and June 30, 2008 and for the three and six months ended  June 30, 2007 and 2008 (unaudited): | ** ** |                 |
| ** **                                                                                                     | Condensed Consolidated Balance Sheets                                                                                                                                             | ** ** | 3                    |
| ** **                                                                                                     | Condensed Consolidated Statements of Income                                                                                                                                       | ** ** | 4                    |
| ** **                                                                                                     | Condensed Consolidated Statements of Changes in Stockholders’ Equity                                                                                                         | ** ** | 5                    |
| ** **                                                                                                     | Condensed Consolidated Statements of Cash Flows                                                                                                                                   | ** ** | 6                    |
| ** **                                                                                                     | Notes to Condensed Consolidated Financial  Statements                                                                                                                             | ** ** | 7                    |
| Item 2 — Management’s Discussion and  Analysis of Financial Condition and Results of Operations | ** **                                                                                                                                                                        | 21         |
| Item 3 — Quantitative and Qualitative  Disclosures About Market Risk                                 | ** **                                                                                                                                                                        | 37         |
| Item 4 - Controls  and Procedures                                                                              | ** **                                                                                                                                                                        | 38         |
|                                                                                                           | ** **                                                                                                                                                                        |       |
| **PART II  – OTHER INFORMATION**                                                                     | ** **                                                                                                                                                                        |       |
| Item 1 – Legal Proceedings                                                                                | ** **                                                                                                                                                                        | 38         |
| Item 1A- Risk Factors                                                                                     | ** **                                                                                                                                                                        | 38         |
| Item 2 – Unregistered Sales of Equity  Securities and Use of Proceeds                                     | ** **                                                                                                                                                                        | 38         |
| Item 3 – Defaults Upon Senior  Securities                                                            | ** **                                                                                                                                                                        | 38         |
| Item 4 — Submission of Matters to a  Vote of Security Holders                                        | ** **                                                                                                                                                                        | 38         |
| Item 5 – Other Information                                                                           | ** **                                                                                                                                                                        | 39         |
| Item 6 — Exhibits                                                                                    | ** **                                                                                                                                                                        | 40         |
|                                                                                                                |                                                                                                                                                                                   |            |                      |  |

 

2

----

Table of Contents

 

**RISKMETRICSGROUP, INC.**

 

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(UNAUDITED)**

**(Inthousands, except share amounts)**

 
| ** **                                                                                                                                                                                                                                                                            | ** ** | **December 31,  2007** | ** ** | **June 30,  2008** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| **ASSETS**                                                                                                                                                                                                                                                                            | ** ** | ** **                  | ** ** | ** **              | ** ** |
| CURRENT ASSETS:                                                                                                                                                                                                                                                                       |       |                        |       |                    |       |
| Cash and cash equivalents                                                                                                                                                                                                                                                             |       | $                           | 27,455     |                    | $          | 108,237 |   |
| Accounts receivable, net                                                                                                                                                                                                                                                              |       | 37,010                      |       | 58,046                  |       |
| Deferred tax asset                                                                                                                                                                                                                                                                    |       | 140                         |       | 140                     |       |
| Income taxes receivable                                                                                                                                                                                                                                                               |       | 8,300                       |       | 9,091                   |       |
| Other receivables and prepaid expenses                                                                                                                                                                                                                                                |       | 5,910                       |       | 7,634                   |       |
| Total current assets                                                                                                                                                                                                                                                                  |       | 78,815                      |       | 183,148                 |       |
| Intangibles—net                                                                                                                                                                                                                                                                  |       | 174,154                     |       | 163,242                 |       |
| Goodwill                                                                                                                                                                                                                                                                              |       | 460,951                     |       | 460,855                 |       |
| Property and equipment—net                                                                                                                                                                                                                                                       |       | 16,225                      |       | 16,004                  |       |
| Deferred financing costs                                                                                                                                                                                                                                                              |       | 8,677                       |       | 5,747                   |       |
| Other assets                                                                                                                                                                                                                                                                          |       | 4,361                       |       | 1,831                   |       |
| TOTAL ASSETS                                                                                                                                                                                                                                                                          |       | $                           | 743,183    |                    | $          | 830,827 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                                         |       |                        |       |                    |       |
| CURRENT LIABILITIES:                                                                                                                                                                                                                                                                  |       |                        |       |                    |       |
| Trade accounts payable                                                                                                                                                                                                                                                                |       | $                           | 6,235      |                    | $          | 7,274 |   |
| Accrued expenses                                                                                                                                                                                                                                                                      |       | 34,189                      |       | 28,032                  |       |
| Debt, current portion                                                                                                                                                                                                                                                                 |       | 3,000                       |       | 741                     |       |
| Deferred revenue, current portion                                                                                                                                                                                                                                                     |       | 100,557                     |       | 114,789                 |       |
| Other current liabilities                                                                                                                                                                                                                                                             |       | 227                         |       | 237                     |       |
| Total current liabilities                                                                                                                                                                                                                                                             |       | 144,208                     |       | 151,073                 |       |
| LONG-TERM LIABILITIES                                                                                                                                                                                                                                                                 |       |                        |       |                    |       |
| Debt                                                                                                                                                                                                                                                                                  |       | 419,750                     |       | 289,878                 |       |
| Deferred tax liabilities                                                                                                                                                                                                                                                              |       | 28,626                      |       | 30,769                  |       |
| Deferred revenue                                                                                                                                                                                                                                                                      |       | 722                         |       | 753                     |       |
| Other long-term liabilities                                                                                                                                                                                                                                                           |       | 13,785                      |       | 12,510                  |       |
| Total liabilities                                                                                                                                                                                                                                                                     |       | $                           | 607,091    |                    | $          | 484,983 |   |
|                                                                                                                                                                                                                                                                                  |       |                        |       |                    |       |
| COMMITMENTS AND CONTINGENCIES                                                                                                                                                                                                                                                         |       |                        |       |                    |       |
|                                                                                                                                                                                                                                                                                  |       |                        |       |                    |       |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                                                                                                                            |       |                        |       |                    |       |
| Common stock, $.01 par value—150,000,000  and 200,000,000 authorized at December 31, 2007 and June 30, 2008,  respectively; 47,850,652 and 60,755,970 issued and 47,642,460 and 60,547,778  outstanding at December 31, 2007 and June 30, 2008, respectively |       | $                           | 479        |                    | $          | 608 |   |
| Treasury stock—208,192 shares                                                                                                                                                                                                                                                    |       | (2                          | )          | (2                      | )          |
| Additional paid-in capital                                                                                                                                                                                                                                                            |       | 217,355                     |       | 420,910                 |       |
| Accumulated other comprehensive loss                                                                                                                                                                                                                                                  |       | (7,262                      | )          | (7,087                  | )          |
| Accumulated deficit                                                                                                                                                                                                                                                                   |       | (74,478                     | )          | (68,585                 | )          |
| Total stockholders’ equity                                                                                                                                                                                                                                                       |       | 136,092                     |       | 345,844                 |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                                                                                                       |       | $                           | 743,183    |                    | $          | 830,827 |   |

 

See notes tocondensed consolidated financial statements.

 

3

----

Tableof Contents

 

**RISKMETRICSGROUP, INC.**

 

**CONDENSED CONSOLIDATED STATEMENTS OF INCOME**

**FORTHE THREE AND SIX MONTHS ENDED JUNE 30, 2007 AND 2008**

** **

**(UNAUDITED)**

 

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

 
| ** **                                                             | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                             | ** ** | **2007**                                        | ** ** | **2008**                                      | ** ** | **2007** | ** ** | **2008** | ** ** |
| REVENUES                                                               |       | $                                               | 58,150     |                                          | $          | 74,126 |   | $ | 110,515 |   | $ | 145,346 |   |
| OPERATING COSTS AND EXPENSES:                                          |       |                                            |       |                                          |       |   |   |   |   |
| Cost of revenues (1)                                                   |       | 19,368                                          |       | 23,176                                        |       | 35,961 |   | 45,880 |   |
| Research and development (1)                                           |       | 7,920                                           |       | 10,405                                        |       | 14,799 |   | 20,866 |   |
| Selling and marketing (1)                                              |       | 8,362                                           |       | 9,280                                         |       | 16,455 |   | 18,486 |   |
| General and administrative (1)                                         |       | 6,437                                           |       | 9,538                                         |       | 12,956 |   | 18,743 |   |
| Depreciation and amortization of property  and equipment               |       | 1,739                                           |       | 2,165                                         |       | 3,323 |   | 4,280 |   |
| Amortization of intangible assets                                      |       | 4,434                                           |       | 5,456                                         |       | 8,623 |   | 10,912 |   |
| Loss on disposal of fixed assets                                       |       | 2                                               |       | 4                                             |       | 2 |   | 26 |   |
| Total operating costs and expenses                                     |       | 48,262                                          |       | 60,024                                        |       | 92,119 |   | 119,193 |   |
| INCOME FROM OPERATIONS                                                 |       | 9,888                                           |       | 14,102                                        |       | 18,396 |   | 26,153 |   |
|                                                                   |       |                                            |       |                                          |       |   |   |   |   |
| INTEREST, DIVIDEND, INVESTMENT, AND OTHER  INCOME (EXPENSE), NET:      |       |                                            |       |                                          |       |   |   |   |   |
|                                                                   |       |                                            |       |                                          |       |   |   |   |   |
| Interest, dividend and investment income                               |       | 400                                             |       | 618                                           |       | 884 |   | 1,241 |   |
| Interest expense (Note 7)                                              |       | (9,335                                          | )          | (5,618                                        | )          | (17,723 | ) | (15,105 | ) |
| Other expenses (Note 7)                                                |       | —                                          |       | —                                        |       | — |   | (2,613 | ) |
| Total interest, dividend, investment, and  other income (expense), net |       | (8,935                                          | )          | (5,000                                        | )          | (16,839 | ) | (16,477 | ) |
| INCOME BEFORE PROVISION FOR INCOME TAXES                               |       | 953                                             |       | 9,102                                         |       | 1,557 |   | 9,676 |   |
| PROVISION FOR INCOME TAXES                                             |       | 497                                             |       | 3,556                                         |       | 812 |   | 3,783 |   |
| NET INCOME                                                             |       | $                                               | 456        |                                          | $          | 5,546 |   | $ | 745 |   | $ | 5,893 |   |
|                                                                   |       |                                            |       |                                          |       |   |   |   |   |
| INCOME PER SHARE:                                                      |       |                                            |       |                                          |       |   |   |   |   |
| Basic                                                                  |       | $                                               | 0.01       |                                          | $          | 0.09 |   | $ | 0.02 |   | $ | 0.10 |   |
| Diluted                                                                |       | $                                               | 0.01       |                                          | $          | 0.08 |   | $ | 0.01 |   | $ | 0.09 |   |
|                                                                   |       |                                            |       |                                          |       |   |   |   |   |
| WEIGHTED AVERAGE NUMBER OF COMMON SHARES  OUTSTANDING:                 |       |                                            |       |                                          |       |   |   |   |   |
|                                                                   |       |                                            |       |                                          |       |   |   |   |   |
| Basic                                                                  |       | 45,600,151                                      |       | 60,522,656                                    |       | 45,309,870 |   | 58,842,179 |   |
| Diluted                                                                |       | 53,878,411                                      |       | 68,046,927                                    |       | 53,589,319 |   | 66,428,885 |   |

 

----

(1) Includes stock-based compensation expense of:

 
| ** **                             | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|----------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                             | ** ** | **2007**                                        | ** ** | **2008**                                      | ** ** | **2007** | ** ** | **2008** | ** ** |
| ** **                             | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cost of revenues                       |       | $                                               | 383        |                                          | $          | 440 |   | $ | 575 |   | $ | 1,998 |   |
| Research and development expenses      |       | 461                                             |       | 671                                           |       | 660 |   | 1,452 |   |
| Selling and marketing expenses         |       | 446                                             |       | 632                                           |       | 553 |   | 953 |   |
| General and administrative expenses    |       | 455                                             |       | 273                                           |       | 753 |   | 974 |   |
| Total stock-based compensation expense |       | $                                               | 1,745      |                                          | $          | 2,016 |   | $ | 2,541 |   | $ | 5,377 |   |

 

See notes tocondensed consolidated financial statements.

 

4

----

Tableof Contents

 

**RISKMETRICSGROUP, INC.**

 

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

**FORTHE SIX MONTHS ENDED JUNE 30, 2008**

 

**(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,  2008                                                                                       |       | 47,850,652                             |       | $          | 479        |                | $          | (2                     | )          | $                       | 217,355    |                     | $          | (7,262 | ) | $ | (74,478 | ) | $ | 136,092 |   |
| Comprehensive  income:                                                                                                   |       |                                   |       |       |       |                |       |                   |       |                    |       |                     |       |   |   |
| Net income                                                                                                               |       | —                                 |       | —     |       | —              |       | —                 |       | —                  |       | 5,893                    |       | 5,893 |   |
| Foreign currency  translation adjustment                                                                                 |       | —                                 |       | —     |       | —              |       | —                 |       | (683                    | )          | —                   |       | (683 | ) |
| Net unrealized  gain on cash flow hedge, net of deferred tax liability of $552 and realized  loss (see disclosure below) |       | —                                 |       | —     |       | —              |       | —                 |       | 858                     |       | —                   |       | 858 |   |
| Total  comprehensive loss                                                                                                |       | —                                 |       | —     |       | —              |       | —                 |       | —                  |       | —                   |       | 6,068 |   |
|                                                                                                                     |       |                                   |       |       |       |                |       |                   |       |                    |       |                     |       |   |   |
| Common shares  issued upon exercise of stock options                                                                     |       | 790,867                                |       | 8          |       | —              |       | 2,951                  |       | —                  |       | —                   |       | 2,959 |   |
| Tax benefit  associated with exercise of stock options                                                                   |       | —                                 |       | —     |       | —              |       | 1,458                  |       | —                  |       | —                   |       | 1,458 |   |
| Stock-based  compensation                                                                                                |       | —                                 |       | —     |       | —              |       | 5,377                  |       | —                  |       | —                   |       | 5,377 |   |
| Issuance of stock  (Note 11)                                                                                             |       | 50,267                                 |       | —     |       | —              |       | —                 |       | —                  |       | —                   |       | — |   |
| Net proceeds from  equity offering (Note 3)                                                                         |       | 12,064,184                             |       | 121        |       | —              |       | 193,769                |       | —                  |       | —                   |       | 193,890 |   |
|                                                                                                                     |       |                                   |       |       |       |                |       |                   |       |                    |       |                     |       |   |   |
| BALANCE—June 30,  2008                                                                                         |       | 60,755,970                             |       | $          | 608        |                | $          | (2                     | )          | $                       | 420,910    |                     | $          | (7,087 | ) | $ | (68,585 | ) | $ | 345,844 |   |
|                                                                                                                     |       |                                   |       |       |       |                |       |                   |       |                    |       |                     |       |   |   |
| Disclosure of  realized loss:                                                                                            |       |                                   |       |       |       |                |       |                   |       |                    |       |                     |       |   |   |
| Unrealized loss  on cash flow hedge                                                                                      |       | $                                      | (1,137     | )          |       |                |       |                   |       |                    |       |                     |       |   |   |   |
| Realized loss for  cash flow hedge settlement , net of tax benefit of $1,351 (Note 8)                                    |       | 1,995                                  |       |       |       |                |       |                   |       |                    |       |                     |       |   |   |
| Net unrealized  gain on cash flow hedge                                                                                  |       | $                                      | 858        |       |       |                |       |                   |       |                    |       |                     |       |   |   |   |

 

See notes tocondensed consolidated financial statements.

 

5

----

Tableof Contents

 

**RISKMETRICSGROUP, INC.**

 

**CONDENSED CONSOLIDATED STATEMENTS OF CASHFLOWS**

**FORTHE SIX MONTHS ENDED JUNE 30, 2007 AND 2008**

 

**(UNAUDITED)**

**(Amountsin thousands)**

 
| ** **                                                                                                                                            | ** ** | **2007**   | ** ** | **2008**   | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                                                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                                                                                       |       | $          | 745        |       | $          | 5,893 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities:                                                                    |       |       |       |       |       |
| Depreciation and amortization of property  and equipment                                                                                              |       | 3,323      |       | 4,280      |       |
| Provision for bad debt                                                                                                                                |       | 132        |       | 763        |       |
| Amortization of intangible assets                                                                                                                     |       | 8,623      |       | 10,912     |       |
| Amortization of debt issuance costs                                                                                                                   |       | 677        |       | 2,930      |       |
| Stock-based compensation                                                                                                                              |       | 2,541      |       | 5,377      |       |
| Tax benefit associated with exercise of  stock options                                                                                                |       | —     |       | (1,458     | )          |
| Loss on disposal of fixed assets                                                                                                                      |       | 2          |       | 26         |       |
| Changes in assets and liabilities:                                                                                                                    |       |       |       |       |       |
| (Increase) decrease in accounts receivable                                                                                                            |       | 1,463      |       | (21,650    | )          |
| Increase in other receivables and prepaid  expenses                                                                                                   |       | (1,640     | )          | (1,732     | )          |
| (Increase) decrease in other assets                                                                                                                   |       | (402       | )          | (103       | )          |
| Increase (decrease) in deferred revenue                                                                                                               |       | (943       | )          | 14,121     |       |
| Decrease in income and deferred taxes                                                                                                                 |       | 412        |       | 2,690      |       |
| Increase (decrease) in trade accounts  payable                                                                                                        |       | (1,321     | )          | 939        |       |
| Decrease in accrued expenses and other  liabilities                                                                                                   |       | (12,478    | )          | (4,485     | )          |
| Net cash provided by operating activities                                                                                                             |       | 1,134      |       | 18,503     |       |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                                                                                 |       |       |       |       |       |
| Purchases of property and equipment                                                                                                                   |       | (3,587     | )          | (3,992     | )          |
| Cash paid to acquire Institutional  Shareholder Services Inc. (“ISS”) and related acquisition costs (net of  cash acquired of $12,250) |       | (471,793   | )          | —     |       |
| Payment of acquired ISS acquisition related  costs                                                                                                    |       | (7,413     | )          | —     |       |
| Purchase of investments                                                                                                                               |       | (21,286    | )          | —     |       |
| Payment for intangible asset                                                                                                                          |       | —     |       | (1,000     | )          |
| Payment of deferred purchase price                                                                                                                    |       | (89        | )          | (139       | )          |
| Proceeds from sale of investments                                                                                                                     |       | 68,235     |       | —     |       |
| Net cash used in investing activities                                                                                                                 |       | (435,933   | )          | (5,131     | )          |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                                                                                 |       |       |       |       |       |
| Proceeds from debt borrowings                                                                                                                         |       | 425,000    |       | —     |       |
| Repayment of debt                                                                                                                                     |       | (750       | )          | (132,131   | )          |
| Payment of debt issuance costs                                                                                                                        |       | (10,074    | )          | —     |       |
| Principal payments on capital lease  obligations                                                                                                      |       | (10        | )          | —     |       |
| Gross proceeds from equity offering (Note  3)                                                                                                         |       | —     |       | 197,400    |       |
| Equity offering expenses                                                                                                                              |       | —     |       | (1,331     | )          |
| Excess tax benefit associated with exercise  of stock options                                                                                         |       | —     |       | 1,458      |       |
| Proceeds from exercise of stock options                                                                                                               |       | 4,659      |       | 2,959      |       |
| Net cash provided by financing activities                                                                                                             |       | 418,825    |       | 68,355     |       |
| EFFECT OF EXCHANGE RATE CHANGES ON CASH                                                                                                               |       | 121        |       | (945       | )          |
| NET (DECREASE) INCREASE IN CASH AND CASH  EQUIVALENTS                                                                                                 |       | (15,853    | )          | 80,782     |       |
| CASH AND CASH EQUIVALENTS—Beginning of  period                                                                                                   |       | 37,313     |       | 27,455     |       |
| CASH AND CASH EQUIVALENTS—End of period                                                                                                          |       | $          | 21,460     |       | $          | 108,237 |   |
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW  INFORMATION:                                                                                                   |       |       |       |       |       |
| Cash paid for interest                                                                                                                                |       | $          | 17,136     |       | $          | 10,064 |   |
| Cash paid for taxes (net of refunds)                                                                                                                  |       | $          | 580        |       | $          | 880 |   |
| NON CASH INVESTING AND FINANCING  ACTIVITIES:                                                                                                         |       |       |       |       |       |
| Issuance of common stock to purchase ISS                                                                                                              |       | $          | 42,426     |       | $          | — |   |
| Issuance of stock options to purchase ISS                                                                                                             |       | $          | 16,331     |       | $          | — |   |
| Retirement of treasury stock                                                                                                                          |       | $          | 103        |       | $          | — |   |
| Tax benefit associated with exercise of ISS  stock options                                                                                            |       | $          | 3,061      |       | $          | 596 |   |

 

See notes tocondensed consolidated financial statements.

 

6

----

Tableof Contents

 

**RISKMETRICS GROUP, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**FOR THETHREE AND SIX MONTHS ENDED JUNE 30, 2008**

**(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***—Theconsolidated financial statements include the accounts of RMG and its whollyowned-subsidiaries which are prepared in accordance with accounting principlesgenerally accepted in the United States of America (US GAAP). Allintercompany accounts and transactions have been eliminated in consolidation.

 

Theaccompanying unaudited condensed consolidated financial statements (the “financialstatements”) have been prepared pursuant to the rules of the Securitiesand Exchange Commission (the “SEC”). Certain information and footnotedisclosures normally included in financial statements prepared in accordancewith accounting principles generally accepted in the United States of Americahave been condensed or omitted pursuant to SEC rules. These financialstatements should be read in conjunction with the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2007.

 

The condensed consolidated financialstatements as of June 30, 2008 and for the three and six months ended June 30,2007 and 2008 in the opinion of management, include all adjustments, consistingonly of normal recurring accruals, necessary to present fairly the Company’sfinancial position, results of operations and cash flows. The operating resultsfor the three and six months ended June 30, 2008 are not necessarilyindicative of the results to be expected for the full year.   The December 31, 2007 condensedconsolidated financial statement information has been derived from the 2007audited consolidated financial statements.

 

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

 

***Use of Estimates and Significant AccountingPolicies****—*Thepreparation of condensed consolidated financial statements in conformity withaccounting principles generally accepted within the United States of America requiresmanagement to make estimates, judgments and assumptions that affect thereported amounts of assets and liabilities and disclosure of contingent assetsand liabilities at the date of the condensed consolidated financial statementsand the reported amounts of revenues and expenses during the reporting period. Significant estimates and assumptions made bymanagement include the deferral and recognition of revenue, impairment ofgoodwill and intangible assets, 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, 2007. The Company believesthe estimates used in the preparation of the condensed consolidated financialstatements are reasonable; however, actual results could differ from thoseestimates.

 

***Effects of Recently Issued AccountingStandards***—In September 2006, the FASB issuedSFAS No. 157, *Fair Value Measurements*.SFAS 157 defines fair value, establishes a framework for measuring fairvalue, and expands disclosures about fair value measurements. In February 2008, the FASB issued FASBStaff Position 157-2, *Effective Date of FASBStatement No. 157*, which provides a one year deferral of theeffective date of SFAS 157 for non-financial assets and liabilities (suchas goodwill), except those that are recognized or disclosed in the Company’sfinancial statements at fair value at least annually. Accordingly, the Companyadopted the provisions of SFAS 157 only for its financial assets andliabilities recognized or disclosed at fair value on a recurring basiseffective January 1, 2008. The Company’s financial assets measured at fairvalue on a recurring basis consist of derivative instruments.  See Note 8 regarding the fair valuemeasurement for the Company’s derivative instruments.

 

In February 2007, the FASB issued SFAS No. 159(“SFAS 159”), *The Fair Value Option forFinancial Assets and Financial Liabilities*, providing companies withan option to report selected financial assets and liabilities at fair value.SFAS 159’s objective is to reduce both complexity in accounting forfinancial instruments and the volatility in earnings caused by measuringrelated assets and liabilities differently. Accounting principles generallyaccepted within the United States have required different measurementattributes for different assets and liabilities that can create artificialvolatility in earnings. SFAS 159 helps to mitigate this type ofaccounting-induced volatility by enabling companies to report related assetsand liabilities at fair value, which would likely reduce the

 

7

----

Table of Contents

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS, continued**

**FOR THETHREE AND SIX MONTHS ENDED JUNE 30, 2008**

 

need for companies to comply with detailed rules for hedgeaccounting. SFAS 159 also establishes presentation and disclosurerequirements designed to facilitate comparisons between companies that choosedifferent measurement attributes for similar types of asset and liabilities.SFAS 159 requires companies to provide additional information that willhelp investors and other users of financial statements to more easilyunderstand the effect of the Company’s choice to use fair value on itsearnings. It also requires entities to display the fair value of these assetsand liabilities for which the Company has chosen to use fair value on the faceof the balance sheet. The Company adopted SFAS 159 on January 1, 2008but did not elect the fair value option for any qualifying financialinstruments presented in the consolidated financial statements.

 

On December 4, 2007, FASB issuedStatement No. 141(R), *BusinessCombinations* (SFAS 141(R)) and Statement No. 160, *Accounting and Reporting of Noncontrolling Interestsin Consolidated Financial Statements*, an amendment of ARB No. 51(SFAS 160). These new standards will significantly change the financialaccounting and reporting of business combination transactions andnoncontrolling (or minority) interests in consolidated financial statements.SFAS 141(R) is required to be adopted concurrently with Statement No. 160and is effective for business combination transactions for which theacquisition date is on or after the beginning of the first annual reportingperiod beginning on or after December 15, 2008. Early adoption is prohibited.Application of SFAS 141(R) and SFAS 160 is generally required tobe adopted prospectively, except for certain provisions of SFAS 160, whichare required to be adopted retrospectively. Business combination transactionsaccounted for before adoption of SFAS 141(R) should be accounted forin accordance with SFAS141 141 and that accounting previously completedunder Statement No. 141 should not be modified as of or after the date ofadoption of Statement No.141(R). The impact of adopting SFAS 141R andSFAS 160 will be dependent on the business combinations that the Company maypursue after its effective date.

 

In March 2008, the FASB issued SFAS No. 161,“*Disclosures about Derivative Instrumentsand Hedging Activities, an amendment of FASB**Statement No. 133*” (“SFAS No. 161”).SFAS No. 161 establishes, among other things, the disclosure requirementsfor derivative instruments and for hedging activities. SFAS No. 161 iseffective for fiscal years and interim periods beginning after November 15,2008. The Company is currently assessing the impact that SFAS No. 161 willhave on its condensed consolidated financial statements.

 

In April 2008, the FASB issued FASB staffposition (“FSP”) FAS 142-3, *Determination ofthe Useful Life of Intangible Assets* (“FSP FAS 142-3”). FSP FAS142-3 amends the factors an entity should consider in developing renewal orextension assumptions used in determining the useful life of recognizedintangible assets under FASB Statement No. 142, “Goodwill and OtherIntangible Assets”. This new guidance applies prospectively to intangibleassets that are acquired individually or with a group of other assets inbusiness combinations and asset acquisitions. FSP FAS 142-3 is effective forfinancial statements issued for fiscal years and interim periods beginningafter December 15, 2008 and as such, the Company will adopt FSP FAS 142-3on January 1, 2009. Early adoption is prohibited. The Company is currentlyevaluating the impact, if any, that FSP FAS 142-3 will have on its consolidatedfinancial statements.

 

**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 theoffering, including the exercise of the underwriters’ allotment, were$193.9 million, after deducting underwriting discounts and commissions andapproximately $3.5 million of offering expenses, of which $1.3 millionwere paid during the six months ended June 30, 2008.   The Company utilized a portion of theproceeds to prepay the entire outstanding indebtedness under the Company’ssecond loan lien credit facility (See Note 7).

 

**4. ACQUISITIONS**

 

*                Institutional Shareholder Services (“ISS”) Acquisition*

 

On January 11, 2007, the Companyacquired all of the outstanding capital stock of ISS for $542,771. The purposeof the acquisition was to broaden the types of services the Company could offerits clients. The acquisition has been accounted for as a purchase and theoperating results of ISS have been included in the financial statements sincethe date of acquisition.

 

The aggregate consideration paid for theacquisition is as follows:

 

| Cash paid                                                                              |   | $      | 482,718 |   |
|----------------------------------------------------------------------------------------|--------|--------|---------|--------|
| Fair value of 2,774,351 shares of common  stock issued                                 |   | 42,426 |    |
| Fair value of stock options exchanged  (1,396,000 shares underlying the stock options) |   | 16,331 |    |
| Transaction costs                                                                      |   | 1,296  |    |
| Total purchase price                                                                   |   | $      | 542,771 |   |

 

8

----

Table of Contents

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS, continued**

**FOR THETHREE AND SIX MONTHS ENDED JUNE 30, 2008**

 

The Company valued the shares of common stockissued in exchange for stock options held by ISS employees and those issued toISS shareholders at $15.29 per share. The fair value of stock options issued inconnection with the acquisition was estimated using the Black-Scholesoption-pricing model utilizing the following weighted-average assumptions:

 

| Risk-free interest rate         |   | 4.7  | %      |
|---------------------------------|--------|------|--------|
| Expected term (in years)        |   | 3.0  |   |
| Expected stock price volatility |   | 31   | %      |
| Expected dividend yield         |   | None |   |

 

The significant assumptions used in thevaluation included factors affecting the duration, growth rates and amounts offuture cash flows for each income stream, specifically: the future economicoutlook for the industry, risks involved in the business, and the input ofcompetition and technological changes. The following table summarizes theamounts allocated to the acquired assets and assumed liabilities based uponmanagement’s estimates:

 

| Cash and cash equivalents and other current  assets |   | $       | 47,770  |   |
|-----------------------------------------------------|--------|---------|---------|--------|
| Property and equipment                              |   | 4,864   |    |
| Non-current assets                                  |   | 13,300  |    |
| Intangible assets                                   |   | 172,339 |    |
| Goodwill                                            |   | 418,317 |    |
| Total assets acquired                               |   | 656,590 |    |
| Accounts payable and accrued expenses               |   | (21,114 | )       |
| Deferred revenue                                    |   | (43,510 | )       |
| Other non-current liabilities                       |   | (1,533  | )       |
| Deferred tax liability                              |   | (47,662 | )       |
| Net assets acquired                                 |   | $       | 542,771 |   |
| Goodwill                                            |   | $       | 418,317 |   |
| Identifiable intangible assets                      |   | 172,339 |    |
| Deferred tax liability                              |   | (47,662 | )       |
| Net liabilities assumed                             |   | (223    | )       |
| Total purchase consideration                        |   | $       | 542,771 |   |

 

In accordance with SFAS No. 109, *Accounting for Income Taxes*, the Companyhas provided for deferred taxes representing the difference between theestimated 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 expected to bedeductible for tax purposes. The Company did not recognize a deferred tax assetrelating to the future tax deduction that will arise when the ISS employeerollover options are exercised. As such exercises occur, the Company recognizesa tax deduction and such benefit is recorded as a reduction of goodwill (Note5).

 

The amounts allocated to intangible assetsand acquired technology were attributed to the following categories andestimated useful lives:

 
| Acquired technology     |   | $       | 25,039  |                          | 5 years |   |
|-------------------------|--------|---------|---------|-------------------------------|--------------|--------|
| Customer relationships  |   | 117,900 |    | 9–11 years          |         |
| Trade names             |   | 29,400  |    | 10 years–indefinite |         |
| Total intangible assets |   | $       | 172,339 |                          |         |   |

 

*Center for Financial Research and Analysis (“CFRA”) Acquisition*

 

On August 1, 2007, the Company acquiredall of the outstanding membership interests of CFRA for $63,793. CFRA is aprovider of forensic accounting research, legal and regulatory risk assessment,due diligence and educational services. The purpose of this acquisition was tobroaden the quantitative and qualitative analysis services that the ISSbusiness could offer its clients. The acquisition has been accounted for as apurchase, and the operating results of CFRA have been included in theconsolidated financial statements since the date of its acquisition.

 

9

----

Tableof Contents

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS, continued**

**FOR THETHREE AND SIX MONTHS ENDED JUNE 30, 2008**

 

The aggregate consideration paid for theacquisition is as follows:

 

| Cash paid (includes cash acquired of  $1,213)          |   | $      | 46,498 |   |
|--------------------------------------------------------|--------|--------|--------|--------|
| Fair value of 1,008,113 shares of common  stock issued |   | 16,634 |   |
| Transaction costs                                      |   | 661    |   |
| Estimated escrow recovery (Note 10).                   |   | (800   | )      |
| Total purchase consideration                           |   | $      | 62,993 |   |

 

The Company valued the shares of common stockissued in exchange for equity held by CFRA shareholders at $16.50 per share.The following table summarizes the amounts allocated to the acquired assets andliabilities assumed based upon management’s estimates:

 

10

----

Tableof Contents

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS, continued**

**FOR THETHREE AND SIX MONTHS ENDED JUNE 30, 2008**

 

| Cash and other current assets         |   | $      | 3,104  |   |
|---------------------------------------|--------|--------|--------|--------|
| Property and equipment                |   | 511    |   |
| Non-current assets                    |   | 49     |   |
| Intangible assets                     |   | 19,710 |   |
| Goodwill                              |   | 46,597 |   |
| Total assets acquired                 |   | 69,971 |   |
| Accounts payable and accrued expenses |   | (3,187 | )      |
| Deferred revenue                      |   | (3,791 | )      |
| Net assets acquired                   |   | $      | 62,993 |   |
| Goodwill                              |   | 46,597 |   |
| Identifiable intangible assets        |   | 19,710 |   |
| Net liabilities assumed               |   | (3,314 | )      |
| Total purchase consideration          |   | $      | 62,993 |   |

 

The amounts and useful lives allocated tointangible assets were as follows:

 
| Customer relationships  |   | $     | 10,250 |         | 7 years |   |
|-------------------------|--------|-------|--------|--------------|--------------|--------|
| Covenant not to compete |   | 250   |   | 1 year  |         |
| Trade name              |   | 100   |   | 1 year  |         |
| Acquired technology     |   | 240   |   | 5 years |         |
| Proprietary process     |   | 8,870 |   | 7 years |         |
| Total intangible assets |   | $     | 19,710 |         |         |   |

 

The purchase consideration,goodwill and liabilities assumed have been adjusted during the three monthsended June 30, 2008 to reflect certain non-income tax liabilities of CFRA(see Note 10).

 

**5. INTANGIBLE ASSETS AND GOODWILL**

 

Intangible assets as of December 31, 2007 and June 30, 2008consist of the following:

 
| ** **              | ** ** | **December 31, 2007** | ** ** |
|-------------------------|------------|---------------------------------|------------|
| ** **              | ** ** | **Useful Lives**           | ** ** | **Gross** | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** |
| Customer relationships  |       | 7–11 years            |       | $ | 128,150 |   | $ | (11,286 | ) | $ | 116,864 |   |
| Acquired technology     |       | 5 years                    |       | 25,279 |   | (4,878 | ) | 20,401 |   |
| Covenant not to compete |       | 1–3 years             |       | 1,500 |   | (208 | ) | 1,292 |   |
| Proprietary process     |       | 7 years                    |       | 8,870 |   | (528 | ) | 8,342 |   |
| Trade names             |       | 1–10 years            |       | 22,800 |   | (2,245 | ) | 20,555 |   |
| Trade names             |       | Indefinite                      |       | 6,700 |   | — |   | 6,700 |   |
| Total                   |       |                            |       | $ | 193,299 |   | $ | (19,145 | ) | $ | 174,154 |   |

 

11

----

Tableof Contents

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS, continued**

**FOR THETHREE AND SIX MONTHS ENDED JUNE 30, 2008**

 
| ** **              | ** ** | **June 30, 2008** | ** ** |
|-------------------------|------------|-----------------------------|------------|
| ** **              | ** ** | **Useful Lives**       | ** ** | **Gross** | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** |
| Customer relationships  |       | 7–11 years        |       | $ | 128,150 |   | $ | (17,518 | ) | $ | 110,632 |   |
| Acquired technology     |       | 5 years                |       | 25,279 |   | (7,406 | ) | 17,873 |   |
| Covenant not to compete |       | 1–3 years         |       | 1,500 |   | (542 | ) | 958 |   |
| Proprietary process     |       | 7 years                |       | 8,870 |   | (1,161 | ) | 7,709 |   |
| Trade names             |       | 1–10 years        |       | 22,800 |   | (3,430 | ) | 19,370 |   |
| Trade names             |       | Indefinite                  |       | 6,700 |   | — |   | 6,700 |   |
| Total                   |       |                        |       | $ | 193,299 |   | $ | (30,057 | ) | $ | 163,242 |   |

 

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,  2008 |   | $      | 10,767 |   |
|--------------------------------------------------|--------|--------|--------|--------|
| Years ending December 31,                   |   |   |   |
| 2009                                             |   | $      | 21,475 |   |
| 2010                                             |   | $      | 21,371 |   |
| 2011                                             |   | $      | 21,058 |   |
| 2012                                             |   | $      | 16,180 |   |

 

Goodwill changed during the six months ended June 30,2008 as follows:

 

| Balance at January 1, 2008                                                                |   | $    | 460,951 |   |
|------------------------------------------------------------------------------------------------|--------|------|---------|--------|
| Tax benefit on exercise of stock options  granted to ISS employees on acquisition (See Note 4) |   | (596 | )       |
| Accrual of CFRA non-income tax liability  (Note 10)                                            |   | 500  |    |
| Balance at June 30, 2008                                                                  |   | $    | 460,855 |   |

 

**6. ACCRUED EXPENSES**

 

Accrued expenses as of December 31, 2007and June 30, 2008 consist of the following:

 

| ** **                              | ** ** | **December 31,  2007** | ** ** | **June 30,  2008** | ** ** |
|-----------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| Accrued compensation and related tax    |       | $                           | 28,490     |                    | $          | 18,445 |   |
| Accrued data expense                    |       | 1,133                       |       | 1,825                   |       |
| Accrued travel and entertainment        |       | 227                         |       | 525                     |       |
| Accrued professional fees               |       | 1,813                       |       | 1,330                   |       |
| Current portion of deferred rent        |       | 202                         |       | 202                     |       |
| CFRA non-income tax liability (Note 10) |       | —                      |       | 1,650                   |       |
| Other accrued expenses                  |       | 2,324                       |       | 4,055                   |       |
|                                    |       | $                           | 34,189     |                    | $          | 28,032 |   |

 

**7. DEBT**

 

In conjunction with the purchase of ISS on January 11,2007, a subsidiary of the Company obtained $450 million of debt, of which$425 million was borrowed to complete the acquisition.

 

The debt is comprised of two term loan facilitiesand a revolving credit facility:

 

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 

 

12

----

Table of Contents

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS, continued**

**FOR THETHREE AND SIX MONTHS ENDED JUNE 30, 2008**

 

loan facility may not be re-borrowed. Amounts repaid under therevolving credit facility may be re-borrowed. The maturity date for therevolving credit facility and first lien term loan facility is January 2013and January 2014, respectively.

 

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 six months ended June 30,2008 in the accompanying consolidated statements of income. In conjunction withthe repayment of the second lien loan during the six months ended June 30,2008, the Company reduced the notional amount of the interest rate swap by$19.3 million, which resulted in other expense of $1.4 million in2008 (Note 8).  The effective interestrate on the Company’s debt was 8.34% and 7.29% for the six months ended June 30,2007 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, starting January 1,2008, the Company is required to make a mandatory payment equal to each year’sexcess cash flow depending on leverage ratios, as defined in the first lienterm loan facility, within five days of delivery of audited financialstatements. During the six months endedJune 30, 2008, the Company made an excess cash flow principal paymentof $6,381 for its first lien term loan. Based on the Company’sconsolidated leverage ratio as of June 30, 2008, no future excess cashflow payments would be required as long as that ratio is maintained. TheCompany is required to repay the aggregate principal remaining on the firstlien term loan facility on the maturity date. The Company may voluntarilyprepay the first lien credit facilities in whole or in part without penalty.

 

Scheduled repayments of balances outstandingas of June 30, 2008 are as follows:

 

| For the twelve months ending June 30, |   |    |    |
|--------------------------------------------|--------|---------|---------|
| 2009                                       |   | $       | 741     |   |
| 2010                                       |   | 2,966   |    |
| 2011                                       |   | 2,966   |    |
| 2012                                       |   | 2,966   |    |
| 2013                                       |   | 2,966   |    |
| Thereafter                                 |   | 278,014 |    |
|                                       |   | $       | 290,619 |   |

 

The Company has guaranteed the payment andperformance of the credit facilities and has pledged all of its assets ascollateral against the debt.

 

The Company incurred debt issuance costs of$10,074, which have been recorded in other long term assets on the accompanyingconsolidated balance sheets. Such amount is being amortized over the life ofthe remaining debt and is reflected as a component of interest expense on theaccompanying statement of income. In conjunction with the prepayment of thesecond lien loan during the six months ended June 30, 2008, the Companywrote-off debt issuance costs of $2,377. The following table summarizesamortization of debt issuance costs in the accompanying consolidated statementsof income:

 

| ** **                          | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                          | ** ** | **2007**                                        | ** ** | **2008**                                      | ** ** | **2007** | ** ** | **2008** | ** ** |
| Amortization of debt issuance costs |       | $                                               | 360        |                                          | $          | 260 |   | $ | 677 |   | $ | 2,930 |   |
|                                     |            |                                                 |            |                                               |            |  |  |  |  |  |  |  |  |

 

**8. FAIR VALUE OF DERIVATIVE INSTRUMENTS**

 

EffectiveJanuary 1, 2008, the Company adopted the provisions of SFAS No. 157that apply to  financial assets andliabilities that are measured at fair value within the financial statements,which provides a framework for measuring fair value under GAAP. As defined inSFAS No. 157, fair value is the price that would be received to sell anasset or paid to transfer a liability in an orderly transaction between marketparticipants at the measurement date. The Company utilizes market data orassumptions that the Company believes market participants would use in pricingthe asset or liability, 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 

 

13

----

Tableof Contents

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS, continued**

**FOR THETHREE AND SIX MONTHS ENDED JUNE 30, 2008**

 

usesthe income approach, which uses valuation techniques to convert future amountsto a single present amount. As of June 30, 2008 the Company had interestrate swap agreements which are valued under a level 2 input as shown in thefollowing table:

 

| ** **                   | ** ** | ** ** | ** ** | **Fair value at June 30, 2008, 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 |       | $          | 9,580      |                                                                  | $          | — |   | $ | 9,580 |   | $ | — |   |
| Total                        |       | $          | 9,580      |                                                                  | $          | — |   | $ | 9,580 |   | $ | — |   |

 

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 consolidated statements of income.

 

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 December 31, 2007 and June 30,2008, the swap agreements had a notional amount of $317,063 and $280,500,respectively. As of December 31, 2007 and June 30, 2008, the swapagreements had a fair value liability of $10,990 and $9,580, respectively,which is included in other long-term liabilities on the accompanyingconsolidated balance sheet.

 

In conjunction with the prepayment of thesecond lien loan during the six months ended June 30, 2008 (Note 7), theCompany reduced the notional amount of the interest rate swap by $19,300 inorder to hedge the remaining debt outstanding. The reduction of the notional amount cost $1,364 and has been includedin other expenses on the accompanying statement of income for the six monthsended June 30, 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 consolidated statements of income. Thegain (loss) from the amortization of the swap agreement is summarized in thefollowing table:

 
| ** **                      | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                      | ** ** | **2007**                                        | ** ** | **2008**                                      | ** ** | **2007** | ** ** | **2008** | ** ** |
| Gain (loss) from swap agreement |       | $                                               | 200        |                                          | $          | (1,699 | ) | $ | 302 |   | $ | (1,914 | ) |
|                                 |            |                                                 |            |                                               |            |  |  |  |  |  |  |  |  |

 

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 that has the same critical terms as the portion of the loan beinghedged. The critical terms of the interest rate swap agreement are identical tothe portion of the loan being hedged as of June 30, 2008. To the extentthat the agreement is not considered to be highly effective in offsetting thechange in the value of the interest payments being hedged, the fair valuerelating to the ineffective portion of such agreement and any subsequentchanges in such fair value will be immediately recognized in earnings. To theextent that the agreement is considered highly effective but not completelyeffective in offsetting the change in the value of the interest payments beinghedged, any changes in fair value relating to the ineffective portion of suchagreement will be immediately recognized in earnings. Effective gains andlosses have been included in the unrealized gain on cash flow hedges as acomponent of other comprehensive income (loss) net of tax.

 

**9. INCOME TAXES**

 

*Income taxes*

 

The expected tax provision calculated at thestatutory federal rate differs from the actual (benefit) provision for the sixmonths ended June 30, 2007 and 2008 is as follows:

 

14

----

Tableof Contents

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS, continued**

**FOR THETHREE AND SIX MONTHS ENDED JUNE 30, 2008**

 
| ** **                                                               | ** ** | **Six months ended  June 30,** | ** ** |
|--------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                               | ** ** | **2007**                                      | ** ** | **2008** | ** ** |
| Tax provision, at U.S. Federal statutory  tax rate                       |       | 35.0                                          | %          | 35.0 | % |
| State and local income tax expense  (benefit), net of U.S. federal taxes |       | (3.3                                          | )%         | 3.9 | % |
| Non-deductible stock option expense under  SFAS 123(R)              |       | 31.3                                          | %          | 1.7 | % |
| Other                                                                    |       | (10.8                                         | )%         | (1.5 | )% |
| Net tax provision                                                        |       | 52.2                                          | %          | 39.1 | % |

 

Other is primarily comprised of foreign tax credits, penalties andforeign income differentials and has declined due to a reduction in researchand development credits and increased projected pre-tax income.

 

*FIN 48*

 

As of June 30, 2008, the Company’sunrecognized tax benefits totaled $1,372, of which $639 would favorably impactthe Company’s effective tax rate, if recognized. The remaining $733 ofliability for unrecognized tax benefits represents deferred tax liabilitiesestablished by ISS effective January 1, 2007. Over the next six months, anincrease of $183 will be recorded for unrecognized tax benefits and suchincrease will unfavorably impact the Company’s income tax provision.  Interest and penalties accrued during the sixmonths ended June 30, 2007 and 2008 were not significant.

 

The Company’s tax returns for 2004-2006remain open to examination by the Internal Revenue Service in their entirety.They also remain open with respect to state taxing jurisdictions.  Currently, the company has been selected foraudit by the Internal Revenue Service for 2006, New York City for 2004-2006 andCanada Revenue Agency for 2005-2006.  Asof June 30, 2008, $268 was accrued for the payment of interest andpenalties.

 

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

 
| Balance at January 1, 2008                               |   | $      | 1,189  |   |
|---------------------------------------------------------------|--------|--------|--------|--------|
| Additions based on tax positions related to  the current year |   | 174    |   |
| Additions for tax positions of prior years                    |   | 9      |   |
| Reductions for tax positions of prior years                   |   | — |   |
| Balance at June 30, 2008                                      |   | $      | 1,372  |   |

** **

**10. COMMITMENTS AND CONTINGENCIES**

 

The Company is committed to unrelated partiesfor the rental of office space under operating leases. As of June 30,2008, minimum future rental payments under operating leases are as follows:

 

| For the twelve months ending June 30, |   |   |   |
|--------------------------------------------|--------|--------|--------|
| 2009                                       |   | $      | 6,574  |   |
| 2010                                       |   | 6,497  |   |
| 2011                                       |   | 5,788  |   |
| 2012                                       |   | 5,409  |   |
| 2013                                       |   | 1,572  |   |
| Thereafter                                 |   | 318    |   |
| Total minimum lease payments               |   | $      | 26,158 |   |

 

Duringthe six months ended June 30, 2008, the Company incurred a $198 lease exitcost as a result of relocating the Company’s London operations and such expensehas been included in general and administrative expenses in the accompanyingstatement of income.

 

15

----

Table of Contents

** **

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS, continued**

**FOR THETHREE AND SIX MONTHS ENDED JUNE 30, 2008**

 

***Data Agreements***—TheCompany has entered into agreements with other vendors to supply the Companywith data. The aggregate minimum payments with respect to these data agreementsas of June 30, 2008, are as follows:

 

| For the  twelve months ending June 30, |   |   |   |
|---------------------------------------------|--------|--------|--------|
| 2009                                        |   | $      | 7,463  |   |
| 2010                                        |   | 2,748  |   |
| 2011                                        |   | 675    |   |
| Total                                       |   | $      | 10,886 |   |

 

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

 

In June 2008, the Company completed an internal study whichdetermined certain non-income tax liabilities are payable in connection withboth the pre-acquisition and post-acquisition operational activity ofCFRA.   The maximum cost of thiscontingency is estimated to be approximately $2,200, however, the Companybelieves the probable cost to be approximately $1,650 of which $1,300 relatesto pre-acquisition activity.  Approximately $800 of the pre-acquisition activity is expected to berecoverable from an escrow agreement and has been recorded in other receivablesand as a reduction to goodwill in the accompanying consolidated balance sheetat June 30, 2008.   The Companyexpects to further analyze and refine this estimated liability and resolve thematter by December 31, 2008. Accordingly, $350 of expense has been recorded in general andadministrative expenses within the accompanying consolidated statement ofincome for the three and six months ended June 30, 2008 and $500 has beenrecorded as an adjustment to CFRA goodwill (See Note 5).

 

**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 June 30,2008, 6,243,266 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.Subsequent to the acquisition of ISS, the Company retired the 2004 plan andadopted a new option plan (the “2007 plan”). As of June 30, 2008,4,567,023 options issued under the 2004 Plan remain outstanding.

 

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 fromISS. Under the adoption of this ISS Plan, no additional options are to beissued. As of June 30, 2008, 163,742 options issued under the ISS Planremain 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 is 6,500,000.As of June 30, 2008, 2,899,342 options issued and 302,842 shares ofnon-vested stock granted under the 2007 Plan remain outstanding.

 

16

----

Table of Contents

** **

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS, continued**

**FOR THETHREE AND SIX MONTHS ENDED JUNE 30, 2008**

 

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

 

| ** **                            | ** ** | **Number of  Shares** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
|---------------------------------------|------------|----------------------------|------------|-----------------------------------------|------------|
| Outstanding—January 1, 2008 |       | 13,361,282                 |       | $                                       | 5.79       |   |
| Granted*                              |       | 1,624,000                  |       | $                                       | 17.52      |   |
| Exercised                             |       | (790,867                   | )          | $                                       | 3.74       |   |
| Forfeited                             |       | (321,042                   | )          | $                                       | 14.69      |   |
| Outstanding—June 30, 2008   |       | 13,873,373                 |       | $                                       | 7.08       |   |

 

----

*Immediately prior to the consummation of theinitial public offering, the Company granted 1,563,500 stock options to itsemployees at an exercise price equal to the initial public offering price of$17.50 per share, including an aggregate of 1,031,500 options related to 2007compensation for certain employees and an aggregate of 532,000 options to allfull time employees, representing a one-time grant of 500 options to each ofour employees. In addition, the Company granted 60,500 options subsequent tothe initial public offering.

 

The Company’s stock options outstanding at June 30, 2008 were asfollows:

 
| ** **           | ** ** | **Outstanding Options** | ** ** | **Options Exercisable**                                        | ** ** |
|----------------------|------------|------------------------------|------------|---------------------------------------------------------------------|------------|
| **Exercise  Prices** | ** ** | **Number of  Options**  | ** ** | **Weighted-Average  Remaining  Contractual  Life  (In Years)** | ** ** | **Weighted-Average  Exercise  Price** | ** ** | **Number of  Options** | ** ** | **Weighted-Average  Exercise  Price** | ** ** |
| $                    | 1.20       |                         | 1,069,458  |                                                                | 2.58       |   | $ | 1.20 |   | 1,069,458 |   | $ | 1.20 |   |
| 1.48                 |       | 85,799                       |       | 3.44                                                                |       | 1.48 |   | 85,799 |   | 1.48 |   |
| 2.00                 |       | 3,248,652                    |       | 4.25                                                                |       | 2.00 |   | 3,248,650 |   | 2.00 |   |
| 2.33                 |       | 4,505                        |       | 4.66                                                                |       | 2.33 |   | 4,505 |   | 2.33 |   |
| 2.40                 |       | 1,925,156                    |       | 5.51                                                                |       | 2.40 |   | 1,909,392 |   | 2.40 |   |
| 3.42                 |       | 20,365                       |       | 5.34                                                                |       | 3.42 |   | 20,365 |   | 3.42 |   |
| 3.75                 |       | 243,125                      |       | 6.18                                                                |       | 3.75 |   | 204,063 |   | 3.75 |   |
| 4.46                 |       | 15,141                       |       | 6.27                                                                |       | 4.46 |   | 15,141 |   | 4.46 |   |
| 4.80                 |       | 1,273,020                    |       | 6.53                                                                |       | 4.80 |   | 931,773 |   | 4.80 |   |
| 5.05                 |       | 17,837                       |       | 6.86                                                                |       | 5.05 |   | 17,837 |   | 5.05 |   |
| 5.94                 |       | 20,095                       |       | 7.62                                                                |       | 5.94 |   | 20,095 |   | 5.94 |   |
| 6.00                 |       | 243,750                      |       | 7.10                                                                |       | 6.00 |   | 141,878 |   | 6.00 |   |
| 7.20                 |       | 1,744,675                    |       | 7.58                                                                |       | 7.20 |   | 826,682 |   | 7.20 |   |
| 15.29                |       | 2,212,734                    |       | 8.69                                                                |       | 15.29 |   | 601,149 |   | 15.29 |   |
| 16.50                |       | 174,061                      |       | 9.09                                                                |       | 16.50 |   | — |   | 16.50 |   |
| 17.50                |       | 1,565,000                    |       | 9.58                                                                |       | 17.50 |   | 205,000 |   | 17.50 |   |
| 19.95                |       | 10,000                       |       | 9.89                                                                |       | 19.95 |   | — |   | 19.95 |   |
|                 |       | 13,873,373                   |       | 6.39                                                                |       | $ | 7.08 |   | 9,301,787 |   | $ | 4.05 |   |
|                      |            |                              |            |                                                                     |            |  |  |  |  |  |  |  |  |  |

 

Of the unvested options as of June 30,2008, 4,022,996 are expected to vest in the future.

 

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  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                      | ** ** | **2007**                                        | ** ** | **2008**                                      | ** ** | **2007** | ** ** | **2008** | ** ** |
| Risk-free interest rate         |       | 4.7                                             | %          | 2.9                                           | %          | 4.7 | % | 2.6 | % |
| Expected term (in years)        |       | 4.5                                             |       | 4.5                                           |       | 4.5 |   | 4.5 |   |
| Expected stock price volatility |       | 29                                              | %          | 35                                            | %          | 29 | % | 35 | % |
| Expected dividend yield         |       | None                                            |       | None                                          |       | None |   | None |   |

 

17

----

Tableof Contents

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS, continued**

**FOR THE THREE AND SIX MONTHS ENDED JUNE 30,2008**

 

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

 
| ** **                                                | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                | ** ** | **2007**                                        | ** ** | **2008**                                      | ** ** | **2007** | ** ** | **2008** | ** ** |
| Weighted average per share fair value of  options granted |       | $                                               | 4.98       |                                          | $          | 6.67 |   | $ | 4.98 |   | $ | 5.77 |   |
|                                                           |            |                                                 |            |                                               |            |  |  |  |  |  |  |  |  |

 

*Non-vested Stock*

 

The following table summarizes non-vestedstock activity for the six months ended June 30, 2008:

 

| ** **                              | ** ** | **Number of  Shares** | ** ** | **Weighted Average   Grant Date  Fair Value** | ** ** |
|-----------------------------------------|------------|----------------------------|------------|-------------------------------------------------------------------|------------|
| Unvested shares at January 1, 2008 |       | 346,609                    |       | $                                                                 | 16.50      |   |
| Granted                                 |       | 6,500                      |       | $                                                                 | 16.84      |   |
| Vested                                  |       | (50,267                    | )          | $                                                                 | 20.43      |   |
| Forfeited                               |       | —                     |       | —                                                            |       |
| Unvested Shares at June 30, 2008   |       | 302,842                    |       | $                                                                 | 16.51      |   |

 

As of June 30, 2008, there wasapproximately $18,971 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.

 

**12. EARNINGS PER SHARE**

 

The Company follows FASB Statement No. 128,*Earnings per Share,* incalculating earnings per share. Basic earnings per common share are computed bydividing net income attributable to common shareholders by the weighted averagenumber of common shares outstanding. Diluted earnings per common share iscomputed 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 intocommon stock, unless they are anti-dilutive.

 

In computing earnings per share for the threeand six months ended June 30, 2007 and 2008, the difference between basicand diluted number of shares outstanding is as follows:

 
| ** **                                                                       | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                       | ** ** | **2007**                                        | ** ** | **2008**                                      | ** ** | **2007** | ** ** | **2008** | ** ** |
| Basic number of weighted-average shares  outstanding                             |       | 45,600,151                                      |       | 60,522,656                                    |       | 45,309,870 |   | 58,842,179 |   |
| Effect of dilutive securities— Employee  stock options and non-vested stock |       | 8,278,260                                       |       | 7,524,271                                     |       | 8,279,449 |   | 7,586,706 |   |
| Diluted number of weighted-average shares  outstanding                           |       | 53,878,411                                      |       | 68,046,927                                    |       | 53,589,319 |   | 66,428,885 |   |

 

Options and non-vested stock of 1,951,457 and1,673,826 common shares during the three months ended June 30, 2007 and2008, and 1,525,273 and 1,524,477 common shares for the six months ended June 30,2007 and 2008, respectively, were anti-dilutive and were therefore excludedfrom the computation of diluted earnings per share.

 

**13. SEGMENT INFORMATION**

 

As of June 30, 2008, the Company has tworeportable 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 

 

18

----

Tableof Contents

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS, continued**

**FOR THE THREE AND SIX MONTHS ENDED JUNE 30,2008**

 

shared services to each segment based on the employee’s geographiclocation and headcount. Goodwill and intangible assets acquired in connectionwith the ISS and CFRA acquisitions are included in the ISS business segmentassets amounts.

 

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 exposure andrisk 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 institutionalinvestors and provides in-depth research and analysis to help inform theirvoting decisions and assess issuer-specific risk. It offers both globalsecurity coverage and fully integrated products and services, from policycreation to comprehensive research, vote recommendations, reliable voteexecution, post-vote disclosure and reporting and analytical tools.

 

Results of operations by segment for the three and six months ended June 30,2007 and 2008 is as follows:

 
| ** **                                               | ** ** | **RiskMetrics  Business** | ** ** | **ISS  Business** | ** ** | **Total** | ** ** |
|----------------------------------------------------------|------------|---------------------------|------------|-------------------|------------|-----------|------------|
| **Three months ended June 30, 2007:**               |       |                      |       |              |       |      |       |
| Revenues                                                 |       | $                         | 29,417     |              | $          | 28,733    |       | $ | 58,150 |   |
| Depreciation and amortization of property  and equipment |       | 1,097                     |       | 642               |       | 1,739     |       |
| Amortization of intangible assets                        |       | —                    |       | 4,434             |       | 4,434     |       |
| Other operating expenses                                 |       | 20,973                    |       | 21,116            |       | 42,089    |       |
| Income from operations                                   |       | $                         | 7,347      |              | $          | 2,541     |       | $ | 9,888 |   |
| Interest, dividend and investment income                 |       |                      |       |              |       | 400       |       |
| Interest expense                                         |       |                      |       |              |       | (9,335    | )          |
| Income before income taxes                               |       |                      |       |              |       | 953       |       |
| Provision for income taxes                               |       |                      |       |              |       | 497       |       |
| Net income                                               |       |                      |       |              |       | $         | 456        |   |
| Asset information at June 30, 2007:                 |       |                      |       |              |       |      |       |
| Segment assets.                                          |       | $                         | 75,876     |              | $          | 649,295   |       | $ | 725,171 |   |
| Goodwill                                                 |       |                      |       | $                 | 420,536    |      | $          | 420,536 |   |

 
| ** **                                               | ** ** | **RiskMetrics  Business** | ** ** | **ISS  Business** | ** ** | **Total** | ** ** |
|----------------------------------------------------------|------------|---------------------------|------------|-------------------|------------|-----------|------------|
| **Three months ended June 30, 2008:**               |       |                      |       |              |       |      |       |
| Revenues                                                 |       | $                         | 38,828     |              | $          | 35,298    |       | $ | 74,126 |   |
| Depreciation and amortization of property  and equipment |       | 1,184                     |       | 981               |       | 2,165     |       |
| Amortization of intangible assets                        |       | —                    |       | 5,456             |       | 5,456     |       |
| Other operating expenses                                 |       | 25,540                    |       | 26,863            |       | 52,403    |       |
| Income from operations                                   |       | $                         | 12,104     |              | $          | 1,998     |       | $ | 14,102 |   |
| Interest, dividend and investment income                 |       |                      |       |              |       | 618       |       |
| Interest expense                                         |       |                      |       |              |       | (5,618    | )          |
| Income before income taxes                               |       |                      |       |              |       | 9,102     |       |
| Provision for income taxes                               |       |                      |       |              |       | 3,556     |       |
| Net income                                               |       |                      |       |              |       | $         | 5,546      |   |
| Asset information at June 30, 2008:                 |       |                      |       |              |       |      |       |
| Segment assets                                           |       | $                         | 138,999    |              | $          | 691,828   |       | $ | 830,827 |   |
| Goodwill                                                 |       |                      |       | $                 | 460,855    |      | $          | 460,855 |   |

 
| ** **                                               | ** ** | **RiskMetrics  Business** | ** ** | **ISS  Business** | ** ** | **Total** | ** ** |
|----------------------------------------------------------|------------|---------------------------|------------|-------------------|------------|-----------|------------|
| **Six months ended June 30, 2007:**                 |       |                      |       |              |       |      |       |
| Revenues                                                 |       | $                         | 56,736     |              | $          | 53,779    |       | $ | 110,515 |   |
| Depreciation and amortization of property  and equipment |       | 2,170                     |       | 1,153             |       | 3,323     |       |
| Amortization of intangible assets                        |       | —                    |       | 8,623             |       | 8,623     |       |
| Other operating expenses                                 |       | 41,270                    |       | 38,903            |       | 80,173    |       |
| Income from operations                                   |       | $                         | 13,296     |              | $          | 5,100     |       | $ | 18,396 |   |
| Interest, dividend and investment income                 |       |                      |       |              |       | 884       |       |
| Interest expense                                         |       |                      |       |              |       | (17,723   | )          |
| Income before income taxes                               |       |                      |       |              |       | 1,557     |       |
| Provision for income taxes                               |       |                      |       |              |       | 812       |       |
| Net income                                               |       |                      |       |              |       | $         | 745        |   |

 

19

----

Table of Contents

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS, continued**

**FOR THE THREE AND SIX MONTHS ENDED JUNE 30,2008**

 
| ** **                                               | ** ** | **RiskMetrics  Business** | ** ** | **ISS  Business** | ** ** | **Total** | ** ** |
|----------------------------------------------------------|------------|---------------------------|------------|-------------------|------------|-----------|------------|
| **Six months ended June 30, 2008:**                 |       |                      |       |              |       |      |       |
| Revenues                                                 |       | $                         | 73,264     |              | $          | 72,082    |       | $ | 145,346 |   |
| Depreciation and amortization of property  and equipment |       | 2,344                     |       | 1,936             |       | 4,280     |       |
| Amortization of intangible assets                        |       | —                    |       | 10,912            |       | 10,912    |       |
| Other operating expenses                                 |       | 49,529                    |       | 54,472            |       | 104,001   |       |
| Income from operations                                   |       | $                         | 21,391     |              | $          | 4,762     |       | $ | 26,153 |   |
| Interest, dividend and investment income                 |       |                      |       |              |       | 1,241     |       |
| Interest expense                                         |       |                      |       |              |       | (15,105   | )          |
| Other expenses                                           |       |                      |       |              |       | (2,613    | )          |
| Income before income taxes                               |       |                      |       |              |       | 9,676     |       |
| Provision for income taxes                               |       |                      |       |              |       | 3,783     |       |
| Net income                                               |       |                      |       |              |       | $         | 5,893      |   |

 

**14. RELATED PARTY TRANSACTION**.

 

In May 2008, the Company entered into a contract for the sale ofMarket Risk products to Duff Capital Advisors. Philip Duff, a director of theCompany, is the founder, CEO and General Partner of Duff Capital Advisors. TheCompany recognized revenue of $170 for the Duff Capital Advisors contract forthe three and six months ended June 30, 2008.

 

20

----

Tableof Contents

 

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

 

*Unless the context otherwise indicates orrequires, as used in this Form 10-Q, references to “we,” “us,” “our” orthe “company” refer to RiskMetrics Group, Inc., and its subsidiaries.References to “RiskMetrics” refer only to our subsidiary, RiskMetrics Solutions, Inc.and its subsidiaries, references to “ISS” refer only to our subsidiaryInstitutional Shareholder Services Holdings, Inc. and its subsidiaries,and references to “CFRA” refer only to our subsidiary RMG-CFRA, LLC,formerly CFRA Holdings, LLC, and its subsidiary.  In this Form 10-Q, all dollar amountsare expressed in thousands, unless indicated otherwise. References to our “clients”include each business unit, division or wholly-owned subsidiary of a parentcompany which has entered into a separate customer contract with us.*

 

*The following discussion and analysis of the financialcondition and results of  operations should be read in conjunctionwith the consolidated financial statements and related notes included elsewherein this Form 10-Q and in our Annual Report on Form 10-K for the yearended December 31, 2007 (the “Form 10-K”). This discussion containsforward-looking statements that involve risks and uncertainties. Our actualresults could differ materially from those discussed below. Factors that couldcause or contribute to such differences include, but are not limited to, thoseidentified below and those discussed 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 experienced high renewal rates. Recurring revenuesaccounted for approximately 92.7% of our total revenues during the six monthsended June 30, 2008, and we had a renewal rate of 89.9% during that time.Our subscription model and high renewal rates minimize volatility in ourrevenues and provide significant visibility for our future 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 adjusted EBITDA margins as ourrevenues have grown.

 

**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 product andservice lines.

 

21

----

Tableof Contents

 

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.

 

***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 price our products andservices based on our clients’ assets under management. As a result, we are notsubject to revenue fluctuations resulting from changes in our clients’ assetsunder management (“AUM”). Our experience has been that, over time, our clientshave often added users and purchased additional products and services from 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 six months ended June 30, 2008, approximately 92.7% of our totalrevenues were generated from these subscription contracts. The subscriptionfees received from our clients are recorded as deferred revenues and recognizedeach month as our services are rendered. Our renewal rate, which was 89.9% forthe six months ended June 30, 2008, combined with our level of newsubscription contracts, determine our annualized contract value, which is aleading indicator of our recurring revenues. Our annualized contract value asof June 30, 2008 was $281,846.

 

We also generate non-recurring revenue fromsales of products and services without a subscription contract, whichrepresented 7.3% of total revenues during the six months ended June 30,2008.

 

*Annualized Contract Value (“ACV”)*

 

As a result of our subscription-based modeland high renewal rates, at the end of any period, we generally havesubscription contracts in place for a high percentage of our total revenues forthe next 12 months. We monitor the contracted revenues from theseagreements 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;

 

·                  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 June 30, 2007, March 31,2008, and June 30, 2008, as well as the percentage growth period overperiod is set forth, separately for each business, in the tables below. ISSyear-over-year ACV growth was complemented by the acquisition of$15.9 million from CFRA on August 1, 2007.

 

22

----

Table of Contents

 

**Year-Over-Year Comparison**

 
| ** **                                      | ** ** | **As of June 30,** | ** ** |
|-------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                      | ** ** | **2007**                          | ** ** | **2008** | ** ** |
| RiskMetrics business annualized contract  value |       | $                                 | 111,680    |   | $ | 155,435 |   |
| Percent growth                                  | * *   | * *                          | * *   | *39.2* | *%* |
| ISS business annualized contract value          |       | $                                 | 97,551     |   | $ | 126,411 |   |
| Percent growth                                  | * *   | * *                          | * *   | *29.6* | *%* |

 

**Sequential Comparison**

 
| ** **                                                         | ** ** | **As of March 31, 2008** | ** **    | **As of June 30, 2008** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------------------|---------------|---------------------------------------------|------------|
| RiskMetrics business annualized contract value |       | $                                            |  142,505 |                                        | $          |  155,435 |   |
| Percent growth                                                     | * *   | * *                                     | * *      | *9.1*                                       | *%*        |
| ISS business annualized contract value                             |       | $                                            | 125,059       |                                        | $          | 126,411 |   |
| Percent growth                                                     | * *   | * *                                     | * *      | *1.1*                                       | *%*        |

 

*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 six months ended June 30, 2007 and 2008, is setforth separately for each business, in the table below.

 
| ** **                        | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------|------------|-----------------------------------------------|------------|
| ** **                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** |
| RiskMetrics business renewal rate |       | 88.4                                          | %          | 90.3 | % |
| ISS business renewal rate         |       | 89.8                                          | %          | 89.4 | % |

 

*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 and six months ended June 30, 2007 and 2008 areset forth in the table below. Our non-subscription services includeimplementation, compensation advisory services and similar services andoverages related to ISS’ Proxy Research and Voting business. Revenues fromimplementation are recognized as the related subscription service is provided,some Compensation Advisory Services revenues are recognized over a three monthperiod and other non-recurring revenues are recognized once the service isprovided. To the extent that clients’ actual usage of proxy voting services orproxy research reports exceeds contracted-for limits, the excess usage isconsidered to be an overage and clients are charged additional fees. Ourclients’ overages are typically an indication of larger proxy voting contractrenewals.

 
| ** **                                          | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                          | ** ** | **2007**                                        | ** ** | **2008**                                      | ** ** | **2007** | ** ** | **2008** | ** ** |
| RiskMetrics business percent non-recurring  revenue |       | 2.7                                             | %          | 1.6                                           | %          | 2.8 | % | 1.3 | % |
| ISS business percent non-recurring revenue          |       | 12.7                                            | %          | 11.5                                          | %          | 14.6 | % | 13.5 | % |

 

***Our Operating Costsand Expenses***

 

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.

 

23

----

Table of Contents

 

Other meaningful operating expenses are data,proxy voting fees, occupancy and telecommunications and web hosting costs.Since we deliver our products and services using a common data and technologyinfrastructure, we expect these expenses to generally increase at less than therate of revenue growth. Overall, our goal is to keep the rate of growth ofthese operating expenses below the rate of growth of our revenues. However, inorder to take advantage of growth opportunities, we may invest in our businessin order to support increased revenue growth. This might result in variabilityin 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 corporate and other shared services to each segment based on usage orheadcount. The following 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 and marketing professionals. These costsinclude staff compensation costs and related expenses, 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.

 

*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. While both leasehold improvements and capitalizedsoftware costs are amortized, they are included in the depreciation line itemin order to segregate amortization of acquired intangibles.

 

*Amortization of Intangible Assets*

 

Amortization expense includes theamortization of finite life intangible assets such as technology, contracts,customer relationships, trade names, license agreements, proprietary processand non-compete agreements acquired, which are amortized over their estimated usefullives.

 

***Adjusted EBITDA***

 

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

 

24

----

Table of Contents

 
| ** **      | ** ** | **Three months ended** | ** ** | ** **                 | ** ** | **Six months ended** | ** ** | ** **                 | ** ** |
|-----------------|------------|----------------------------------|------------|----------------------------|------------|--------------------------------|------------|----------------------------|------------|
| ** **      | ** ** | **June 30,**                | ** ** | **% Growth for** | ** ** | **June 30,**              | ** ** | **% Growth for** | ** ** |
| ** **      | ** ** | **2007**                         | ** ** | **2008**                   | ** ** | **three months**          | ** ** | **2007**                   | ** ** | **2008** | ** ** | **six months** | ** ** |
|            |       |                             |       |                       |       |                           |       |                       |       |   |   |   |   |
| Adjusted EBITDA |       | $                                | 17,808     |                       | $          | 23,743                         |       | 33.3                       | %          | $ | 32,885 |   | $ | 46,946 |   | 42.8 | % |
|                 |            |                                  |            |                            |            |                                |            |                            |            |  |  |  |  |  |  |  |  |

 

Adjusted EBITDA for the six months ended June 30, 2007 does notinclude $0.9 million generated from ISS from January 1 through January 11,2007 as ISS was acquired on January 11, 2007.  In addition, AdjustedEBITDA growth was favorably impacted by the acquisition of CFRA on August 1,2007.

 

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 andequipment, amortization of intangible assets, non-cash stock-based compensationexpense and extraordinary or non-recurring charges or expenses. It is amaterial metric used by our lenders in evaluating compliance with the maximumconsolidated leverage ratio covenant in our credit facilities. The maximumconsolidated leverage ratio covenant, as defined in our credit facilities,represents the ratio of total indebtedness as compared to Adjusted EBITDA, andcan not exceed a maximum ratio range which declines from 8.50 to 3.00 over thelife of the credit facilities. Non-compliance with this covenant could resultin us being required to immediately repay our outstanding indebtedness underour credit facilities. Adjusted EBITDA is also a metric used by management tomeasure operating 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 interestexpense), tax position (such as the impact on periods of changes in effectivetax rates or net operating losses), the age and book depreciation of fixedassets (affecting relative depreciation expense), acquisitions (affectingamortization expense) and compensation plans (affecting stock-basedcompensation 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 as reportedunder U.S. GAAP. Some of these limitations are:

 

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

 

·                                          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.

 

25

----

Tableof Contents

 

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

 
| ** **                                               | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|----------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                               | ** ** | **2007**                                        | ** ** | **2008**                                      | ** ** | **2007** | ** ** | **2008** | ** ** |
| Net income                                               |       | $                                               | 456        |                                          | $          | 5,546 |   | $ | 745 |   | $ | 5,893 |   |
| Interest, other expense, net                             |       | 8,935                                           |       | 5,000                                         |       | 16,839 |   | 16,477 |   |
| Income tax expense                                       |       | 497                                             |       | 3,556                                         |       | 812 |   | 3,783 |   |
| Depreciation and amortization of property  and equipment |       | 1,739                                           |       | 2,165                                         |       | 3,323 |   | 4,280 |   |
| Amortization of intangible assets                        |       | 4,434                                           |       | 5,456                                         |       | 8,623 |   | 10,912 |   |
| Stock-based compensation.                                |       | 1,745                                           |       | 2,016                                         |       | 2,541 |   | 5,377 |   |
| Non-recurring expenses (a)                               |       | —                                          |       | —                                        |       | — |   | 198 |   |
| Loss on disposal of property and equipment               |       | 2                                               |       | 4                                             |       | 2 |   | 26 |   |
| Adjusted EBITDA                                          |       | $                                               | 17,808     |                                          | $          | 23,743 |   | $ | 32,885 |   | $ | 46,946 |   |

 

----

(a) Represents lease exitcosts incurred from moving the London operations.

 

**Critical Accounting Policies and Estimates**

 

Ourcondensed consolidated financial statements are prepared in conformity withaccounting principles generally accepted in the United States. Our criticalaccounting policies, including the assumptions and judgments underlying them,require the application of significant judgment in the preparation of ourfinancial statements, and as a result they are subject to a greater degree ofuncertainty. In applying these policies, we use our judgment to determine theappropriate assumptions to be used in calculating estimates that affect thereported amounts of assets, liabilities, revenues and expenses. Estimates andassumptions are based on historical experience and on various other factorsthat are believed to be reasonable under the circumstances. Accordingly, actualresults could differ from those estimates. Significant estimates andassumptions made by management include the deferral and recognition of revenue,impairment of goodwill and intangible assets, stock-based compensation, gainsor losses on derivative instruments, accounting for income taxes and othermatters that affect the condensed consolidated financial statements and relateddisclosures.  There have been no changes to our significant accountingpolicies since December 31, 2007.

 

**Results of Operations**

 

We operate in two segments, “the RiskMetricsbusiness” and the “ISS business.” We have provided a discussion of our resultsof operations on a consolidated basis and have also provided certain detaileddiscussions for each of our segments.

 

*Factors Affecting the Comparability ofResults*

 

The results of ISS are not included in ourresults of operations until the acquisition date of January 11, 2007. Inaddition, the financial results of CFRA, which was acquired on August 1,2007, have been included in the results of our ISS business only since the dateof its acquisition. CFRA supplements the ISS business to support the FinancialResearch and Analysis product and services offerings.

 

In January 2008, we completed an initial public offering of16,100,000 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 sellingstockholders.  As such, weightedaverage common shares outstanding for the three and six months ended June 30,2008 includes 12,100,000 additional shares sold in the initial public offering.In addition, immediately prior to the completion of our initial publicoffering we granted each of our full-time employees an option to acquire 500shares of our common stock, at an exercise price equal to the initial publicoffering price. Such grant resulted in stock based compensation of $244 and$1,601 being recorded for the three and six months ended June 30, 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 six months ended June 30,2008, 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 of incomefor the six months ended June 30, 2008.

 

26

----

Tableof Contents

 

*Three months ended June 30, 2007compared to the three months ended June 30, 2008*

 

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

 

**Consolidated RiskMetrics Group, Inc.**

 
| ** **                                                      | ** ** | **Three months ended  June 30,**                    | ** ** | **Increase (decrease)** | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                      | ** ** | **2007**                                                           | ** ** | **2008**                     | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                                      | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Revenues                                                        |       | $                                                                  | 58,150     |                         | $          | 74,126 |   | $ | 15,976 |   | 27.5 | % |
| Operating costs and expenses:                                   |       |                                                               |       |                         |       |   |   |   |   |
| Cost of revenues                                                |       | 19,368                                                             |       | 23,176                       |       | 3,808 |   | 19.7 | % |
| Research and development                                        |       | 7,920                                                              |       | 10,405                       |       | 2,485 |   | 31.4 | % |
| Selling and marketing                                           |       | 8,362                                                              |       | 9,280                        |       | 918 |   | 11.0 | % |
| General and administrative                                      |       | 6,437                                                              |       | 9,538                        |       | 3,101 |   | 48.2 | % |
| Depreciation and amortization of property  and equipment        |       | 1,739                                                              |       | 2,165                        |       | 426 |   | 24.5 | % |
| Amortization of intangible assets                               |       | 4,434                                                              |       | 5,456                        |       | 1,022 |   | 23.0 | % |
| Loss on disposal of fixed assets                                |       | 2                                                                  |       | 4                            |       | 2 |   | 100.0 | % |
| Total operating costs and expenses(1)                           |       | 48,262                                                             |       | 60,024                       |       | 11,762 |   | 24.4 | % |
| Income from operations                                          |       | 9,888                                                              |       | 14,102                       |       | 4,214 |   | 42.6 | % |
| Interest, dividend, investment and other  income (expense), net |       | (8,935                                                             | )          | (5,000                       | )          | (3,935 | ) | (44.0 | )% |
| Income before provision for income taxes                        |       | 953                                                                |       | 9,102                        |       | 8,149 |   | 855.1 | % |
| Provision for income taxes                                      |       | 497                                                                |       | 3,556                        |       | 3,059 |   | 615.5 | % |
| Net income                                                      |       | $                                                                  | 456        |                         | $          | 5,546 |   | $ | 5,090 |   | 1,116.2 | % |

 

----

(1) Includes stock-based compensation expense of $1,745 and $2,016for the three months ended June 30, 2007 and 2008, respectively.

 

**RiskMetrics Business**

 
| ** **                                               | ** ** | **Three months ended  June 30,**                    | ** ** | **Increase (decrease)** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                               | ** ** | **2007**                                                           | ** ** | **2008**                     | ** ** | **$** | ** ** | ** %** | ** ** |
| ** **                                               | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Revenues                                                 |       | $                                                                  | 29,417     |                         | $          | 38,828 |   | $ | 9,411 |   | 32.0 | % |
| Operating costs and expenses:                            |       |                                                               |       |                         |       |   |   |   |   |
| Cost of revenues                                         |       | 7,470                                                              |       | 8,647                        |       | 1,177 |   | 15.8 | % |
| Research and development                                 |       | 6,088                                                              |       | 7,077                        |       | 989 |   | 16.2 | % |
| Selling and marketing                                    |       | 4,076                                                              |       | 5,023                        |       | 947 |   | 23.2 | % |
| General and administrative                               |       | 3,337                                                              |       | 4,802                        |       | 1,465 |   | 43.9 | % |
| Depreciation and amortization of property  and equipment |       | 1,097                                                              |       | 1,184                        |       | 87 |   | 7.9 | % |
| Loss (gain) on disposal of fixed assets                  |       | 2                                                                  |       | (9                           | )          | (11 | ) | (550.0 | )% |
| Total operating costs and expenses(2)                    |       | 22,070                                                             |       | 26,724                       |       | 4,654 |   | 21.1 | % |
| Income from operations                                   |       | $                                                                  | 7,347      |                         | $          | 12,104 |   | 4,757 |   | 64.7 | % |
|                                                          |            |                                                                    |            |                              |            |  |  |  |  |  |  |  |

 

----

(2) Includes stock-based compensation expense of $822 and $788 forthe three months ended June 30, 2007 and 2008, respectively.

 

**ISS Business**

 
| ** **                                               | ** ** | **Three months ended  June 30,**                    | ** ** | **Increase (decrease)** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                               | ** ** | **2007**                                                           | ** ** | **2008**                     | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                               | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Revenues                                                 |       | $                                                                  | 28,733     |                         | $          | 35,298 |   | $ | 6,565 |   | 22.8 | % |
| Operating costs and expenses:                            |       |                                                               |       |                         |       |   |   |   |   |
| Cost of revenues                                         |       | 11,898                                                             |       | 14,529                       |       | 2,631 |   | 22.1 | % |
| Research and development                                 |       | 1,832                                                              |       | 3,328                        |       | 1,496 |   | 81.7 | % |
| Selling and marketing                                    |       | 4,286                                                              |       | 4,257                        |       | (29 | ) | (0.7 | )% |
| General and administrative                               |       | 3,100                                                              |       | 4,736                        |       | 1,636 |   | 52.8 | % |
| Depreciation and amortization of property  and equipment |       | 642                                                                |       | 981                          |       | 339 |   | 52.8 | % |
| Amortization of intangible assets.                       |       | 4,434                                                              |       | 5,456                        |       | 1,022 |   | 23.0 | % |
| Loss on disposal of fixed assets                         |       | —                                                             |       | 13                           |       | 13 |   | — |   |
| Total operating costs and expenses(3)                    |       | 26,192                                                             |       | 33,300                       |       | 7,108 |   | 27.1 | % |
| Income from operations                                   |       | $                                                                  | 2,541      |                         | $          | 1,998 |   | (543 | ) | (21.4 | )% |
|                                                          |            |                                                                    |            |                              |            |  |  |  |  |  |  |  |

 

----

(3) Includes stock-based compensation expense of $923 and $1,228for the three months ended June 30, 2007 and 2008, respectively.

 

27

----

Tableof Contents

 

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

 

**Consolidated RiskMetrics Group, Inc.**

 
| ** **                            | ** ** | **Three months ended  June 30, 2007**          | ** ** | **Three months ended  June 30, 2008** | ** ** | **Increase (decrease)** | ** ** |
|---------------------------------------|------------|--------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|------------------------------|------------|
| **Region**                            | ** ** | **Revenue**                                                        | ** ** | **% of  Total  Revenue**                             | ** ** | **Revenue**                  | ** ** | **% of  Total  Revenue** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                            | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Americas                              |       | $                                                                  | 35,992     |                                                      | 61.9       | %                            | $          | 45,608 |   | 61.5 | % | $ | 9,616 |   | 26.7 | % |
| Europe, Middle East and Africa (EMEA) |       | 18,185                                                             |       | 31.3                                                      | %          | 24,179                       |       | 32.6 | % | 5,994 |   | 33.0 | % |
| Asia                                  |       | 3,973                                                              |       | 6.8                                                       | %          | 4,339                        |       | 5.9 | % | 366 |   | 9.2 | % |
| Total                                 |       | $                                                                  | 58,150     |                                                      | 100.0      | %                            | $          | 74,126 |   | 100.0 | % | $ | 15,976 |   | 27.5 | % |

 

**RiskMetrics Business**

 
| ** **                            | ** ** | **Three months ended  June 30, 2007**          | ** ** | **Three months ended  June 30, 2008** | ** ** | **Increase (decrease)** | ** ** |
|---------------------------------------|------------|--------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|------------------------------|------------|
| **Region**                            | ** ** | **Revenue**                                                        | ** ** | **% of  Total  Revenue**                             | ** ** | **Revenue**                  | ** ** | **% of  Total  Revenue** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                            | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Americas                              |       | $                                                                  | 13,568     |                                                      | 46.1       | %                            | $          | 17,893 |   | 46.1 | % | $ | 4,325 |   | 31.9 | % |
| Europe, Middle East and Africa (EMEA) |       | 13,276                                                             |       | 45.1                                                      | %          | 18,216                       |       | 46.9 | % | 4,940 |   | 37.2 | % |
| Asia                                  |       | 2,573                                                              |       | 8.8                                                       | %          | 2,719                        |       | 7.0 | % | 146 |   | 5.7 | % |
| Total                                 |       | $                                                                  | 29,417     |                                                      | 100.0      | %                            | $          | 38,828 |   | 100.0 | % | $ | 9,411 |   | 32.0 | % |

 

**ISSBusiness**

 
| ** **                            | ** ** | **Three months ended  June 30, 2007** | ** ** | **Three months ended  June 30, 2008** | ** ** | **Increase (decrease)** | ** ** |
|---------------------------------------|------------|-----------------------------------------------------------|------------|-----------------------------------------------------------|------------|------------------------------|------------|
| ** **                            | ** ** | ** **                                                | ** ** | **% of Total**                                  | ** ** | ** **                   | ** ** | **% of Total** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Region**                            | ** ** | **Revenue**                                               | ** ** | **Revenue**                                               | ** ** | **Revenue**                  | ** ** | **Revenue** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                            | ** ** | **(Amounts  in thousands, except percentages)**           | ** ** |
| Americas                              |       | $                                                         | 22,424     |                                                      | 78.0       | %                            | $          | 27,715 |   | 78.5 | % | $ | 5,291 |   | 23.6 | % |
| Europe, Middle East and Africa (EMEA) |       | 4,909                                                     |       | 17.1                                                      | %          | 5,963                        |       | 16.9 | % | 1,054 |   | 21.5 | % |
| Asia                                  |       | 1,400                                                     |       | 4.9                                                       | %          | 1,620                        |       | 4.6 | % | 220 |   | 15.7 | % |
| Total                                 |       | $                                                         | 28,733     |                                                      | 100.0      | %                            | $          | 35,298 |   | 100.0 | % | $ | 6,565 |   | 22.8 | % |

 

Set forth below is a discussion of ourresults for the three months ended June 30, 2007 compared to the threemonths ended June 30, 2008.

 

*Revenues.* Consolidated revenues increased from$58.2 million for the three months ended June 30, 2007 to $74.1million for the three months ended June 30, 2008, or 27.5%. Revenue growth was driven by a 32.0% increasein the RiskMetrics business and 22.8% increase in the ISS business.

 

RiskMetrics revenues increased from$29.4 million for the three months ended June 30, 2007 to $38.8million for the three months ended June 30, 2008, or 32.0%. The $9.4million increase in revenues was primarily due to a $9.1 million, or 36.1%,increase in revenues from our Market Risk products and services.  The increase in revenues from Market RiskProducts was due to a 41.8% increase in revenues from RiskManager due to strongsales of RiskManager to asset managers and hedge funds as they increased theiroutsourcing of risk reporting services. Increased revenues resulted from bothincreased sales to existing customers and sales to new customers. As apercentage of total revenues, revenues from our Market Risk products andservices increased from 85.3% for the three months ended June 30, 2007 to87.9% for the three months ended June 30, 2008.  Revenue growth was also driven by a 31.9%increase in the Americas region and a 37.2% 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 Revenuesincreased $6.6 million from $28.7 million for the three months ended June 30,2007 to $35.3 million for the three months ended June 30, 2008, or 22.8%.The increase in revenues was primarily due to an increase in revenue from ourFinancial Research and Analysis products and services which increased from $6.7million to $11.9 million due to the inclusion of $4.3 million of CFRA revenue,which was acquired on August 1, 2007, and the growth of our revenues fromour Corporate and Compensation Advisory Services, ES&G and M&A Edgeproducts. Revenues from our Governance Services products increased 6.3% from $22.0million to $23.4 million due to increased revenue in all proxy research andvoting services. Governance services revenue accounted for 66.3% of totalrevenue for the three months ended June 30, 2008 compared to 76.6% in theprior year.

 

*Operating costs and expenses.* Consolidated operating expenses increased from $48.3 million forthe three months ended June 30, 2007 to $60.0 million for the three monthsended June 30, 2008, or 24.4%. The increase in operating expenses was dueto the 

 

28

----

Tableof Contents

 

acquisitionof CFRA, increases in compensations costs, occupancy, data, accountinginsurance and consulting costs as a result of being a public company as well asprovisions for bad debt.  As a percentageof revenue, operating expenses decreased from 83.0% to 81.0% due to increasedeconomies of scale.

 

RiskMetrics operating expenses increased from$22.1 million for the three months ended June 30, 2007 to $26.7 millionfor the three months ended June 30, 2008, or 21.1%. The increase wasmainly due to increased compensation costs of $1.6 million related to higherheadcount, bonus accrual and commission increases, as well as increased data,and occupancy costs and accounting, insurance and consulting costs as a resultof being a public company.  As apercentage of revenues, operating expenses decreased from 75.0% to 68.8% due toincreased economies of scale.

 

ISS operatingexpenses increased from $26.2 million for the three months ended June 30,2007 to $33.3 million for the three months ended June 30, 2008, or 27.1%.The increase in operating expenses was primarily due to increased compensationcosts of $3.8 million (including CFRA), additional operating expenses fromCFRA, increased amortization expense of $1.0 million, increased provisions forbad debt as well as increased occupancy and recruiting costs.  As a percentage of revenues, operating costsand expenses increased from 91.2% to 94.3% primarily due to an increase inamortization expense and increased investment in research and developmentrelated to Governance Services products and platforms.

 

*Cost of revenues.*  Consolidated cost of revenues increased from$19.4 million for the three months ended June 30, 2007 to $23.2million for the three months ended June 30, 2008, or 19.7%. As apercentage of revenues, cost of revenues decreased from 33.3% to 31.3%primarily from increased margins in the RiskMetrics business, partially offsetby increases at ISS as a result of provisions for bad debt of $0.5 million andadditional CFRA costs which historically has a higher cost of revenue.

 

RiskMetrics cost of revenues increased from$7.5 million for the three months ended June 30, 2007 to $8.6 million forthe three months ended June 30, 2008, or 15.8%. The increase was primarilydue to increased compensation costs and increase in third- party data costs of$0.5 million due to the increased breadth of product offerings.  As a percentage of revenues, cost of revenuesdecreased from 25.4% to 22.3% due to increased economies of scale.

 

ISS cost ofrevenues increased from $11.9 million for the three months ended June 30,2007 to $14.5 million for the three months ended June 30, 2008, or 22.1%.The increase was primarily due to CFRA costs, increased compensation costs,including stock-based compensation and increased provisions for bad debt.  As a percentage of revenues, cost of revenuesdecreased from 41.4% to 41.2%.

 

*Research and development expenses.*  Consolidated research and developmentexpenses increased from $7.9 million for the three months ended June 30,2007 to $10.4 million for the three months ended June 30, 2008, or 31.4%.As a percentage of revenues, research and development expenses increased from13.6% to 14.0% primarily due to increased compensation costs and increasedinvestment in research and development related to Governance Services productsand platforms.

 

RiskMetrics research and development expensesincreased from $6.1 million for the three months ended June 30, 2007 to$7.1 million for the three months ended June 30, 2008, or 16.2%. Theincrease was primarily due to increased employee compensation costs due to anincreased focus in market risk product development.

 

ISS research anddevelopment expenses increased from $1.8 million for the three months ended June 30,2007 to $3.3 million for the three months ended June 30, 2008, or 81.7%.The increase was primarily due to increased compensation costs, CFRA costs andinvestment in research and development related to governance service productsand platforms.

 

*Selling and marketing expenses.*  Consolidated selling and marketing expensesincreased from $8.4 million for the three months ended June 30, 2007to $9.3 million for the three months ended June 30, 2008, or 11.0%. As apercentage of revenues, selling and marketing expenses decreased from 14.4% to12.5% due to the synergies achieved from the integration of the Company’sglobal sales force and lower marketing expenses as a percentage of revenues.

 

RiskMetrics selling and marketing expensesincreased from $4.1 million for the three months ended June 30, 2007to $5.0 million for the three months ended June 30, 2008, or 23.2%. Theincrease was primarily due to increased commissions as a result of the increasein sales and increased marketing expenses.

 

ISS selling andmarketing expenses remained steady at $4.3 million for the three months ended June 30,2007 and 2008.  ISS selling and marketingexpenses were impacted by the inclusion of CFRA costs in 2008, reducedmarketing expenses and benefits from the integration of the global sale force.

 

*General and administrative expenses.*  Consolidated general and administrativeexpenses increased from $6.4 million for the three months ended June 30,2007 to $9.5 million for the three months ended June 30, 2008, or 48.2%.As a percentage of revenues, 

 

29

----

Tableof Contents

 

general and administrative expenses increased from 11.1% to 12.9% dueto increased compensation, accounting, consulting and insurance costs as aresult of being a public company as well as increased occupancy costs.

 

RiskMetrics general and administrative expensesincreased from $3.3 million for the three months ended June 30, 2007 to$4.8 million for the three months ended June 30, 2008, or 43.9%. Theincrease was primarily due to increased employee compensation due to increasedheadcount as well as increased accounting, insurance and consulting costs andoccupancy costs.

 

ISS general andadministrative expenses increased from $3.1 million for the three months ended June 30,2007 to $4.7 million for the three months ended June 30, 2008, or 52.8%.The increase was primarily due to a $0.4 million non-income tax charge fromCFRA, additional CFRA costs and increased occupancy costs.

 

*Depreciation and amortization of property andequipment.* Depreciation and amortization of property and equipment increased from$1.7 million for the three months ended June 30, 2007 to $2.2 millionfor the three months ended June 30, 2008. The increase was primarily dueto an increase in capital expenditures for leasehold improvements and computersto support the Company’s increased headcount and facilities expansion.

 

*Amortization of intangible assets.*  Amortization of intangible assets increasedfrom $4.4 million for the three months ended June 30, 2007 to $5.5million for the three months ended June 30, 2008 primarily from our acquisitionof CFRA on August 1, 2007 and purchase of an intangible asset.

 

*Interest, dividend and investment income(expense), net.* Net interest, dividend and investment expense decreased from $8.9million for the three months ended June 30, 2007 to $5.0 million for thethree months ended June 30, 2008. In January 2008, we utilized aportion of proceeds from the initial public offering to prepay the entireoutstanding indebtedness under the second lien loan, in the amount of$125.0 million. As a result of the IPO and debt prepayment, interestexpense decreased and interest income increased as a result of reduced debtborrowings and increased cash balances during 2008. We expect this trend oflower interest expense and increased interest income to continue for theremainder of fiscal 2008.

 

*Provision for income taxes.*  The provision for income taxes represents aneffective tax rate of 39.1% for the three months ended June 30, 2008 ascompared to an effective rate of 52.2% for the comparable prior year period.The effective rate changed mainly due to a decrease in non-deductible stockbased compensation expense and increased pre-tax income. Effective tax ratesare subject to change based on the taxable income in all the jurisdictions inwhich we do business.

 

30

----

Table of Contents

 

*Six months ended June 30, 2007 comparedto the six months ended June 30, 2008*

 

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

 

**ConsolidatedRiskMetrics Group, Inc.**

 
| ** **                                                      | ** ** | **Six months ended  June 30,**                      | ** ** | **Increase (decrease)** | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                      | ** ** | **2007**                                                           | ** ** | **2008**                     | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                                      | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Revenues                                                        |       | $                                                                  | 110,515    |                         | $          | 145,346 |   | $ | 34,831 |   | 31.5 | % |
| Operating costs and expenses:                                   |       |                                                               |       |                         |       |   |   |   |   |
| Cost of revenues                                                |       | 35,961                                                             |       | 45,880                       |       | 9,919 |   | 27.6 | % |
| Research and development                                        |       | 14,799                                                             |       | 20,866                       |       | 6,067 |   | 41.0 | % |
| Selling and marketing                                           |       | 16,455                                                             |       | 18,486                       |       | 2,031 |   | 12.3 | % |
| General and administrative                                      |       | 12,956                                                             |       | 18,743                       |       | 5,787 |   | 44.7 | % |
| Depreciation and amortization of property  and equipment        |       | 3,323                                                              |       | 4,280                        |       | 957 |   | 28.8 | % |
| Amortization of intangible assets                               |       | 8,623                                                              |       | 10,912                       |       | 2,289 |   | 26.6 | % |
| Loss on disposal of fixed assets                                |       | 2                                                                  |       | 26                           |       | 24 |   | * |   |
| Total operating costs and expenses(1)                           |       | 92,119                                                             |       | 119,193                      |       | 27,074 |   | 29.4 | % |
| Income from operations                                          |       | 18,396                                                             |       | 26,153                       |       | 7,757 |   | 42.2 | % |
| Interest, dividend, investment and other  income (expense), net |       | (16,839                                                            | )          | (16,477                      | )          | (362 | ) | (2.1 | )% |
| Income before provision for income taxes                        |       | 1,557                                                              |       | 9,676                        |       | 8,119 |   | 521.4 | % |
| Provision for income taxes                                      |       | 812                                                                |       | 3,783                        |       | 2,971 |   | 365.9 | % |
| Net income                                                      |       | $                                                                  | 745        |                         | $          | 5,893 |   | $ | 5,148 |   | 691.0 | % |

 

----

(1) Includes stock-based compensation expense of $2,541 and $5,377for the six months ended June 30, 2007 and 2008, respectively.

 

**RiskMetrics Business**

 
| ** **                                               | ** ** | **Six months ended  June 30,**                      | ** ** | **Increase (decrease)** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                               | ** ** | **2007**                                                           | ** ** | **2008**                     | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                               | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Revenues                                                 |       | $                                                                  | 56,736     |                         | $          | 73,264 |   | $ | 16,528 |   | 29.1 | % |
| Operating costs and expenses:                            |       |                                                               |       |                         |       |   |   |   |   |
| Cost of revenues                                         |       | 14,879                                                             |       | 16,780                       |       | 1,901 |   | 12.8 | % |
| Research and development                                 |       | 11,744                                                             |       | 14,156                       |       | 2,412 |   | 20.5 | % |
| Selling and marketing                                    |       | 8,103                                                              |       | 9,353                        |       | 1,250 |   | 15.4 | % |
| General and administrative                               |       | 6,542                                                              |       | 9,240                        |       | 2,698 |   | 41.2 | % |
| Depreciation and amortization of property  and equipment |       | 2,170                                                              |       | 2,344                        |       | 174 |   | 8.0 | % |
| Loss on disposal of fixed assets                         |       | 2                                                                  |       | —                       |       | (2 | ) | * |   |
| Total operating costs and expenses(2)                    |       | 43,440                                                             |       | 51,873                       |       | 8,433 |   | 19.4 | % |
| Income from operations                                   |       | $                                                                  | 13,296     |                         | $          | 21,391 |   | 8,095 |   | 60.9 | % |
|                                                          |            |                                                                    |            |                              |            |  |  |  |  |  |  |  |

 

----

(2) Includes stock-based compensation expense of $1,618 and $2,126for the six months ended June 30, 2007 and 2008, respectively.

 

**ISS Business**

 
| ** **                                               | ** ** | **Six months ended  June 30,**                      | ** ** | **Increase (decrease)** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                               | ** ** | **2007**                                                           | ** ** | **2008**                     | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                               | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Revenues                                                 |       | $                                                                  | 53,779     |                         | $          | 72,082 |   | $ | 18,303 |   | 34.0 | % |
| Operating costs and expenses:                            |       |                                                               |       |                         |       |   |   |   |   |
| Cost of revenues                                         |       | 21,082                                                             |       | 29,100                       |       | 8,018 |   | 38.0 | % |
| Research and development                                 |       | 3,055                                                              |       | 6,710                        |       | 3,655 |   | 119.6 | % |
| Selling and marketing                                    |       | 8,352                                                              |       | 9,133                        |       | 781 |   | 9.4 | % |
| General and administrative                               |       | 6,414                                                              |       | 9,503                        |       | 3,089 |   | 48.2 | % |
| Depreciation and amortization of property  and equipment |       | 1,153                                                              |       | 1,936                        |       | 783 |   | 67.9 | % |
| Amortization of intangible assets                        |       | 8,623                                                              |       | 10,912                       |       | 2,289 |   | 26.6 | % |
| Loss on disposal of fixed assets                         |       | —                                                             |       | 26                           |       | 26 |   | * |   |
| Total operating costs and expenses(2)                    |       | 48,679                                                             |       | 67,320                       |       | 18,641 |   | 38.3 | % |
| Income from operations                                   |       | $                                                                  | 5,100      |                         | $          | 4,762 |   | (338 | ) | (6.6 | )% |
|                                                          |            |                                                                    |            |                              |            |  |  |  |  |  |  |  |

 

----

(3) Includes stock-based compensation expense of $923 and $3,251for the six months ended June 30, 2007 and 2008, respectively.* exceeds 1,000%

 

31

----

Tableof Contents

 

The following table provides information with respect to ourconsolidated and segment revenues in certain geographic regions:

 

**Consolidated RiskMetrics Group, Inc.**

 
| ** **                            | ** ** | **Six months ended  June 30, 2007**            | ** ** | **Six months ended  June 30, 2008** | ** ** | ** **  | ** ** |
|---------------------------------------|------------|--------------------------------------------------------------------|------------|---------------------------------------------------------|------------|-------------|------------|
| ** **                            | ** ** | ** **                                                         | ** ** | **% of **                                     | ** ** | ** **  | ** ** | **% of** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                            | ** ** | ** **                                                         | ** ** | **Total**                                               | ** ** | ** **  | ** ** | **Total** | ** ** | **Increase (decrease)** | ** ** |
| **Region**                            | ** ** | **Revenue**                                                        | ** ** | **Revenue**                                             | ** ** | **Revenue** | ** ** | **Revenue** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                            | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Americas                              |       | $                                                                  | 68,905     |                                                    | 62.3       | %           | $          | 90,239 |   | 62.1 | % | $ | 21,334 |   | 31.0 | % |
| Europe, Middle East and Africa (EMEA) |       | 34,375                                                             |       | 31.1                                                    | %          | 46,564      |       | 32.0 | % | 12,189 |   | 35.5 | % |
| Asia                                  |       | 7,235                                                              |       | 6.6                                                     | %          | 8,543       |       | 5.9 | % | 1,308 |   | 18.1 | % |
| Total                                 |       | $                                                                  | 110,515    |                                                    | 100        | %           | $          | 145,346 |   | 100.0 | % | $ | 34,831 |   | 31.5 | % |

 

**RiskMetrics Business**

 
| ** **                            | ** ** | **Six months ended  June 30, 2007**            | ** ** | **Six months ended  June 30, 2008** | ** ** | ** **  | ** ** |
|---------------------------------------|------------|--------------------------------------------------------------------|------------|---------------------------------------------------------|------------|-------------|------------|
| ** **                            | ** ** | ** **                                                         | ** ** | **% of **                                     | ** ** | ** **  | ** ** | **% of ** | ** ** | ** ** | ** ** |
| ** **                            | ** ** | ** **                                                         | ** ** | **Total**                                               | ** ** | ** **  | ** ** | **Total** | ** ** | **Increase (decrease)** | ** ** |
| **Region**                            | ** ** | **Revenue**                                                        | ** ** | **Revenue**                                             | ** ** | **Revenue** | ** ** | **Revenue** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                            | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Americas                              |       | $                                                                  | 26,326     |                                                    | 46.4       | %           | $          | 33,427 |   | 45.6 | % | $ | 7,101 |   | 27.0 | % |
| Europe, Middle East and Africa (EMEA) |       | 25,675                                                             |       | 45.3                                                    | %          | 34,491      |       | 47.1 | % | 8,816 |   | 34.3 | % |
| Asia                                  |       | 4,735                                                              |       | 8.3                                                     | %          | 5,346       |       | 7.3 | % | 611 |   | 12.9 | % |
| Total                                 |       | $                                                                  | 56,736     |                                                    | 100        | %           | $          | 73,264 |   | 100.0 | % | $ | 16,528 |   | 29.1 | % |

** **

**ISSBusiness**

 
| ** **                            | ** ** | **January 12, 2007  to June 30, 2007** | ** ** | **Six months ended  June 30, 2008** | ** ** | ** **  | ** ** |
|---------------------------------------|------------|-----------------------------------------------------------------|------------|---------------------------------------------------------|------------|-------------|------------|
| ** **                            | ** ** | ** **                                                      | ** ** | **% of Total**                                | ** ** | ** **  | ** ** | **% of Total** | ** ** | **Increase (decrease)** | ** ** |
| **Region**                            | ** ** | **Revenue**                                                     | ** ** | **Revenue**                                             | ** ** | **Revenue** | ** ** | **Revenue** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                            | ** ** | **(Amounts  in thousands, except percentages)**                 | ** ** |
| Americas                              |       | $                                                               | 42,579     |                                                    | 79.2       | %           | $          | 56,812 |   | 78.9 | % | $ | 14,233 |   | 33.4 | % |
| Europe, Middle East and Africa (EMEA) |       | 8,700                                                           |       | 16.2                                                    | %          | 12,073      |       | 16.7 | % | 3,373 |   | 38.8 | % |
| Asia                                  |       | 2,500                                                           |       | 4.6                                                     | %          | 3,197       |       | 4.4 | % | 697 |   | 27.9 | % |
| Total                                 |       | $                                                               | 53,779     |                                                    | 100        | %           | $          | 72,082 |   | 100.0 | % | $ | 18,303 |   | 34.0 | % |

 

Set forth below is a discussion of ourresults for the six months ended June 30, 2007 compared to the six monthsended June 30, 2008.

 

*Revenues.* Consolidated revenues increased from$110.5 million for the six months ended June 30, 2007 to $145.3million for the six months ended June 30, 2008, or 31.5%. Revenue growth was driven by a 29.1% increasein the RiskMetrics business and 34.0% increase in the ISS business. Inaddition, ISS revenue growth was impacted by the acquisition of CFRA whichgenerated $8.7 million of revenue, the inclusion of 11 additional days in thesix months ended June 30, 2008 and organic revenue growth in thegovernance services and financial research and analysis product lines.

 

RiskMetrics revenues increased from$56.7 million for the six months ended June 30, 2007 to $73.3 millionfor the six months ended June 30, 2008, or 29.1%. The $16.5 millionincrease in revenues was primarily due to a $16.2 million, or 33.6%, increasein revenues from our Market Risk products. The increase in revenues from Market Risk Products was due to 40.4%increase in revenues from RiskManager due to strong sales of RiskManager toasset managers and hedge funds as they increased their outsourcing of riskreporting services.  As a percentage oftotal revenues, revenues from our Market Risk products and services increasedfrom 84.9% for the six months ended June 30, 2007 to 87.9% for the sixmonths ended June 30, 2008.  Revenuegrowth was also driven by a 27.0% increase in the Americas region and a 34.3%increase in the EMEA region driven by strong sales of RiskManager in theseregions due to, among other things, increased investor demand and the need forfinancial services firms to comply with regulatory requirements.

 

ISS revenuesincreased from $53.8 million for the period from January 12, 2007 to June 30,2007 to $72.1 million for the six months ended June 30, 2008, or 34.0%.During the period from January 1 to January 11, 2007, ISS recognizedrevenues of $3.3 million. Had these eleven days of revenue been included in thesix months ended June 30, 2007, revenue would have been $57.1 million, anincrease of 26.2% as compared to the six months ended June 30, 2008. Allthe information provided in the remainder of this paragraph reflects theinclusion of the revenues for this 11-day period. The increase in revenues wasprimarily due to a $11.3 million increase in revenue from our FinancialResearch and Analysis products and services which increased from $15.0 millionto $26.3 million, or 75.4%, due to the inclusion of $8.7 million of CFRArevenue, which was acquired on August 1, 2007, and growth of our revenuesfrom our Corporate and Compensation Advisory Services, ES&G and M&AEdge products. Revenues from our Governance Services products increased 8.7%from $42.1 million to $45.8 million due to increased revenue in all proxyresearch and voting services. Governance services revenue accounted for 63.5%of total revenue for the six months ended June 30, 2008 compared 

 

32

----

Table of Contents

 

to 73.8% in the prior year. Revenues from the Americas accounted for78.9% of ISS revenues in the six months ended June 30, 2008, down from79.2% in the six months ended June 30, 2007, as ISS continued to diversifygeographically, partially offset by the increase in CFRA revenues.

 

*Operating costs and expenses.* Consolidating operating expenses increased from $92.1 million forthe six months ended June 30, 2007 to $119.2 million for the six monthsended June 30, 2008, or 29.4%. The increase in operating expenses was dueto the acquisition of CFRA, increased compensation expense of $12.9 million,increased stock based compensation of $2.8 million, including $1.4 million ofIPO charges, as well as increased recruiting, data, occupancy, accounting andconsulting costs. As a percentage of revenue, operating expenses decreased from83.4% to 82.0% due to increased economies of scale partially offset byincreased amortization and stock-based compensation expense.

 

RiskMetrics operating expenses increased from$43.4 million for the six months ended June 30, 2007 to $51.9 million forthe six months ended June 30, 2008, or 19.4%. The increase was mainly dueto increased compensation costs of $3.7 million related to higher headcount,bonus accrual and commission increases, as well as increased data, occupancyand accounting insurance and consulting costs. As a percentage of revenues, operatingexpenses decreased from 76.6% to 70.8% due to increased economies of scale.

 

ISS operatingexpenses increased from $48.7 million for the period from January 12, 2007to June 30, 2007 to $67.3 million for the six months ended June 30,2008, or 38.3%. The increase in operating expenses was primarily due toincreased compensation costs of $9.2 million (including CFRA), operatingexpenses of CFRA, increased amortization expense of $2.3 million, a $2.3million increase in stock-based compensation expense, increased occupancy costsand the inclusion of 11 additional days in the 2008 period. As a percentage ofrevenues, operating costs and expenses increased from 90.5% to 93.4% primarilydue to increases in stock based compensation, amortization expense and investmentin research and development related to governance service products andplatforms.

 

*Cost of revenues.*  Consolidated cost of revenues increased from$36.0 million for the six months ended June 30, 2007 to $45.9 millionfor the six months ended June 30, 2008, or 27.6%. As a percentage ofrevenues, cost of revenues decreased from 32.5% to 31.6%. The increase in costof revenues resulted primarily from increased compensation, includingstock-based compensation of $1.4 million, increased data costs and increases atISS as a result of CFRA costs which historically have a higher cost of revenue,partially offset by increased margins in the RiskMetrics business.

 

RiskMetrics cost of revenues increased from$14.9 million for the six months ended June 30, 2007 to $16.8 million forthe six months ended June 30, 2008, or 12.8%. The increase was primarilydue to increased compensation costs and a $0.7 million increase in third- partydata costs due to the increased breadth of product offerings.  As a percentage of revenues, Risk cost ofrevenues decreased from 26.2% to 22.9% due to increased economics of scale.

 

ISS cost ofrevenues increased from $21.1 million for the period from January 12,2007 to June 30, 2007 to $29.1 million for the six months ended June 30,2008, or 38.0%. The increase was primarily due to CFRA costs, bad debtprovisions and compensation costs, including stock-based compensation of $1.3million and occupancy costs.  As apercentage of revenues, ISS cost of revenues increased from 39.2% to 40.3% as aresult of increased stock based compensation and the CFRA acquisition whichhistorically generates a higher cost of revenue.

 

*Research and development expenses.*  Consolidated research and developmentexpenses increased from $14.8 million for the six months ended June 30,2007 to $20.9 million for the six months ended June 30, 2008, or 41.0%. Asa percentage of revenues, research and development expenses increased from13.4% to 14.4% primarily due to increased compensation costs, includingstock-based compensation and increased investment in research and developmentrelated to governance service products and platforms.

 

RiskMetrics research and development expensesincreased from $11.7 million for the six months ended June 30, 2007 to$14.2 million for the six months ended June 30, 2008, or 20.5%. Theincrease was primarily due to increased employee compensation costs related tothe continued investment in market risk product development.

 

ISS research anddevelopment expenses increased from $3.1 million for the period from January 12,2007 to June 30, 2007 to $6.7 million for the six months ended June 30,2008, or 119.6%. The increase was primarily due to increased compensationcosts, including stock-based compensation of $0.7 million, CFRA costs andinvestment in research and development related to governance service productsand platforms.

 

*Selling and marketing expenses.*  Consolidated selling and marketing expensesincreased from $16.5 million for the six months ended June 30, 2007to $18.5 million for the six months ended June 30, 2008, or 12.3%. As apercentage of revenues, selling and marketing expenses decreased from 14.9% to12.7% due to synergies achieved from the integration of the Company’s globalsales force and lower marketing expenses as a percentage of revenues.

 

33

----

Table of Contents

 

RiskMetrics selling and marketing expensesincreased from $8.1 million for the six months ended June 30, 2007 to$9.4 million for the six months ended June 30, 2008, or 15.4%. Theincrease was primarily due to increased commissions as a result of the increasein sales.

 

ISS selling andmarketing expenses increased from $8.4 million for the period from January 12,2007 to June 30, 2007 to $9.1 million for the six months ended June 30,2008, or 9.4%. The increase was primarily due to the inclusion of CFRA costs in2008 and increased compensation, including stock-based compensation expense aswell as increased marketing expenses.

 

*General and administrative expenses.*  Consolidated general and administrativeexpenses increased from $13.0 million for the six months ended June 30,2007 to $18.7 million for the six months ended June 30, 2008, or 44.7%. Asa percentage of revenues, general and administrative expenses increased from11.7% to 12.9% due to increased occupancy costs, increased compensation costsand accounting, insurance and consulting costs as a result of being a publiccompany.

 

RiskMetrics general and administrativeexpenses increased from $6.5 million for the six months ended June 30,2007 to $9.2 million for the six months ended June 30, 2008, or 41.2%. Theincrease was primarily due to increased occupancy costs, employee compensationand accounting, insurance and consulting costs as a result of being a publiccompany.

 

ISS general andadministrative expenses increased from $6.4 million for the period from January 12,2007 to June 30, 2007 to $9.5 million for the six months ended June 30,2008, or 48.2%. The increase was primarily due to increased compensation,including stock-based compensation expenses and CFRA costs.

 

*Depreciation and amortization of property andequipment.* Depreciation and amortization of property and equipment increased from$3.3 million for the six months ended June 30, 2007 to $4.3 millionfor the six months ended June 30, 2008. The increase was primarily due toan increase in capital expenditures for leasehold improvements and computers tosupport the Company’s increased headcount and facilities expansion.

 

*Amortization of intangible assets.*  Amortization of intangible assets increasedfrom $8.6 million for the six months ended June 30, 2007 to $10.9 millionfor the six months ended June 30, 2008 primarily from our acquisition ofCFRA on August 1, 2007 and purchase of an intangible asset.

 

*Interest, dividend and investment income(expense), net.* Net interest, dividend and investment expense decreased from$16.8 million for the six months ended June 30, 2007 to $16.5 millionfor the six months ended June 30, 2008. This decrease in expense was due to decreased interest expense (net ofamortization) and increased interest income as a result of reduced debtborrowings and increased cash balances during 2008. We expect this trend oflower interest expense and increased interest income to continue for theremainder of fiscal 2008.  In January 2008,we utilized a portion of proceeds from the initial public offering to prepaythe entire outstanding indebtedness under the second lien loan, in the amountof $125.0 million. As a result of the prepayment we incurred $5.0 millionin expenses during the six months ended June 30, 2008, which werecomprised of a $1.25 million debt prepayment penalty fee, a $2.4 millionwrite-off of debt issuance costs and a $1.4 million loss on an interestrate swap settlement.

 

*Provision for income taxes.*  The provision for income taxes represents aneffective tax rate of 39.1% for the six months ended June 30, 2008 ascompared to an effective rate of 52.2% for the comparable prior year period.The effective rate changed mainly due to a decrease in non-deductible stockbased compensation expense and increased pre-tax income. Effective tax ratesare subject to change based on the taxable income in all the jurisdictions inwhich we do business.

 

**Liquidity and Capital Resources**

 

At June 30, 2008 and December 31,2007, we had cash and cash equivalents of $108.2 million and$27.5 million, respectively.  In January 2008,we completed an initial public offering of our common stock.  Our net proceeds from the offering, includingthe exercise of the underwriters’ allotment, were $193.9 million, afterdeducting underwriting discounts and commissions and approximately$3.5 million of offering expenses, of which we utilized$125.0 million to repay in full our second loan lien. We believe ourexisting cash and cash equivalents, our cash flow from operating activities andavailability under our existing credit facilities will be sufficient to meetour anticipated cash needs for at least the next 12 months, during whichtime we expect to make approximately $11.0 million to $12.0 millionof capital expenditures. Our future working capital requirements will depend onmany factors, including our revenue growth, debt service, future acquisitionsof businesses and investments in our own business. To the extent, our liquiditysources are insufficient to fund our future activities we may need to raiseadditional funding through a public or private equity or debt offering. Noassurances can be given that additional financing will be available in thefuture or that if available, such financing will be on favorable terms.

 

34

----

Table of Contents

 

*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 generate more cash flows from operations during the second halfof the year than during the first half of the year.

 

Cash flows from operating activitiesincreased by $17.4 million in 2008 compared to 2007 due to increased net incomeas well as a $7.1 million decline in cash paid for interest due to a reductionin debt borrowings and interest rates and increased contribution from workingcapital.   Operating activities for the six monthsended June 30, 2008 provided cash of $18.5 million primarily reflecting net income of $5.9 million plusdepreciation and amortization of $15.2 million, and a $2.7 million decrease inincome and deferred taxes partially offset by a $4.5 million decline in accruedexpenses due to bonus payments and a $7.5 million net decrease in accountsreceivable and deferred revenue.  Cash flow from operations in 2008 wasnegatively impacted by $1.3 million of cash used for a debt pre-payment penaltyfee and $1.4 million for an interest rate swap settlement in connection withthe pre-payment of debt in 2008. Operating activities for the six months ended June 30, 2007provided cash of $1.1 million primarily reflecting net income of $0.8 millionplus depreciation and amortization of $11.9 million, plus stock-basedcompensation of $2.5 million partially offset by a $12.5 million decline inaccrued expenses due to bonus payments.

 

Investing activities for the six months endedJune 30, 2008 used cash of $5.1 million, primarily due tocapital expenditures of $4.0 million and payment for an intangible asset.Investing activities for the three months ended June 30, 2007 used cash of$435.9 million, primarilydue to the acquisition of ISS, which included the liquidation of investmentsthat provided us $46.9 million of cash, as well as capital expenditures of$3.6 million.

 

Financing activities for the six months endedJune 30, 2008 provided cash of $68.4 million as a result of$197.4 million raisedfrom our initial public offering partially offset by $132.1 million in debtpayments. Financing activities for the six months ended June 30, 2007provided cash of $418.8 millionas a result of proceeds received from the incurrence of $425.0 million ofindebtedness in connection with the ISS acquisition and $4.6 million in stockoption proceeds, partially offset by $10.1 million in debt issuance costs.

 

*Long Term Debt*

 

In connection with the purchase of ISS on January 11,2007, we incurred $425.0 million of indebtedness. The indebtedness wascomprised of first lien and second lien term loans. We also entered into afirst lien revolving credit facility. The terms of the indebtedness includevarious covenant compliance requirements, including maintaining certainAdjusted EBITDA earning levels, as defined in our credit facilities. TheCompany has pledged all of its assets as collateral against the debt. Amountspaid under the term loans may not be re-borrowed. The maturity dates of thefirst lien loan, second lien loan and revolving credit facility loans are January 2013,January 2014 and July 2014, respectively.

 

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 June 30,2008, the interest rate swaps had notional principle amounts of $280,500 and afair value liability of $9,580. The agreements effectively convert ourfloating-rate debt into fixed-rate debt. This reduces our risk of incurringhigher interest costs in periods of rising interest rates and increases ourrisk of paying higher interest costs in periods of decreasing interest rates.Our interest-rate swap agreements hedge a significant portion of the interestrate risk exposure under our indebtedness. The interest rate swap agreementsincreased our weighted average effective interest rate on the first lien termloan facility to 7.29% during the six months ended June 30, 2008. Theinterest rate on the Company’s debt was reduced by 25 basis points in April 2008due to a reduction in the Company’s consolidated debt-leverage ratio.  The variable benchmark interest rates onEurodollar based loans associated with these instruments ranged from 2.70% to4.83% during the six months ended June 30, 2008.

 

In January 2008, we utilized a portionof proceeds from our initial public offering to prepay the entire outstandingindebtedness under our second lien loan which amounted to $125.0 million.In addition, we paid a 1% prepayment penalty fee, or $1.25 million, uponrepayment as set forth in the credit agreement. In conjunction with the repaymentof our second loan lien, we wrote-off debt issuance costs of $2.4 millionand reduced the notional amount of our interest rate swap by $19.3 millionwhich resulted in additional expense of $1.4 million during the six monthsended June 30, 2008. During the six months ended June 30, 2008, wepaid an excess cash flow principal payment of $6.4 million for our first lienterm loan, as required by the credit facility. The next principal debt paymentof $0.7 million is due on June 30, 2009.

 

As of June 30, 2008, we were incompliance with our credit agreements, and we are not aware of any futureevents or transactions that will impact such compliance.

 

35

----

Table of Contents

 

*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 June 30, 2008:

 
| ** **                            | ** ** | **Payments Due by Period** | ** ** |
|---------------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligation**       | ** ** | **Total**                                 | ** ** | **Within 1 year** | ** ** | **1-3 years** | ** ** | **4-5 years** | ** ** | **After 5 years** | ** ** |
| Debt, including estimated interest    |       | $                                         | 391,137    |   | $ | 21,265 |   | $ | 46,348 |   | $ | 45,508 |   | $ | 278,016 |   |
| Operating leases                      |       | 26,158                                    |       | 6,574 |   | 12,285 |   | 6,981 |   | 318 |   |
| Purchase obligation for data          |       | 10,886                                    |       | 7,463 |   | 3,423 |   | — |   | — |   |
| Deferred purchase price obligation(1) |       | 1,164                                     |       | 211 |   | 453 |   | 500 |   | — |   |
| Total                                 |       | $                                         | 429,345    |   | $ | 35,513 |   | $ | 62,509 |   | $ | 52,989 |   | $ | 278,334 |   |

 

----

(1)                                  Obligationrelates to prior acquisitions made by ISS.

 

*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*

 

In May 2008,we entered into a contract for the sale of Market Risk products to Duff CapitalAdvisors. Philip Duff, a director of the Company, is the founder, CEO andGeneral Partner of Duff Capital Advisors. The contract was entered into in thenormal course of business on terms that are consistent with (and notpreferential to) those provided to our other clients. We recognized $170 inrevenue from the Duff Capital Advisors contract for the three and six monthsended June 30, 2008.

 

**Effects of Recently Issued AccountingPronouncements**

 

In September 2006, the FASB issued SFAS No. 157, *Fair Value Measurements*. SFAS 157defines fair value, establishes a framework for measuring fair value, andexpands disclosures about fair value measurements. In February 2008,the FASB issued FASB Staff Position 157-2, *EffectiveDate of FASB Statement No. 157*, which provides a one yeardeferral of the effective date of SFAS 157 for non-financial assets andliabilities (such as goodwill), except those that are recognized or disclosedin the Company’s financial statements at fair value at least annually.Accordingly, we adopted the provisions of SFAS 157 only for its financialassets and liabilities recognized or disclosed at fair value on a recurringbasis effective January 1, 2008. The Company’s financial assets measuredat fair value on a recurring basis consist of derivative instruments.  See Note 8 of the condensed consolidatedfinancial statements regarding the fair value measurement for the Company’sderivative instruments.

 

In February 2007, the FASB issued SFAS No. 159(“SFAS 159”), *The Fair Value Option forFinancial Assets and Financial Liabilities*, providing companies withan option to report selected financial assets and liabilities at fair value.SFAS 159’s objective is to reduce both complexity in accounting forfinancial instruments and the volatility in earnings caused by measuringrelated assets and liabilities differently. Accounting principles generallyaccepted within the United States have required different measurementattributes for different assets and liabilities that can create artificialvolatility in earnings. SFAS 159 helps to mitigate this type ofaccounting-induced volatility by enabling companies to report related assetsand liabilities at fair value, which would likely reduce the need for companiesto comply with detailed rules for hedge accounting. SFAS 159 alsoestablishes presentation and disclosure requirements designed to facilitatecomparisons between companies that choose different measurement attributes forsimilar types of asset and liabilities. SFAS 159 requires companies toprovide additional information that will help investors and other users offinancial statements to more easily understand the effect of the Company’schoice to use fair value on its earnings. It also requires entities to displaythe fair value of these assets and liabilities for which the Company has chosento use fair value on the face of the balance sheet. The Company adoptedSFAS 159 on January 1, 2008 but did not elect the fair value optionfor any qualifying financial instruments presented in the consolidatedfinancial statements.

 

36

----

Table of Contents

 

On December 4, 2007, FASB issuedStatement No. 141(R), *BusinessCombinations* (SFAS 141(R)) and Statement No. 160, *Accounting and Reporting of Noncontrolling Interestsin Consolidated Financial Statements*, an amendment of ARB No. 51(SFAS 160). These new standards will significantly change the financialaccounting and reporting of business combination transactions andnoncontrolling (or minority) interests in consolidated financial statements.SFAS 141(R) is generally required to be adopted concurrently withStatement No. 160 and is effective for business combination transactionsfor which the acquisition date is on or after the beginning of the first annualreporting period beginning on or after December 15, 2008. Early adoptionis prohibited. Application of SFAS 141(R) and SFAS 160 isrequired to be adopted prospectively, except for certain provisions ofSFAS 160, which are required to be adopted retrospectively. Businesscombination transactions accounted for before adoption of SFAS 141(R) shouldbe accounted for in accordance with SFAS141 141 and that accountingpreviously completed under Statement No. 141 should not be modified as ofor after the date of adoption of Statement No.141(R). The impact ofadopting SFAS 141R and SFAS 160 will be dependent on the business combinationsthat the Company may pursue after its effective date.

 

In March 2008, the FASB issued SFAS No. 161,“*Disclosures about Derivative Instrumentsand Hedging Activities, an amendment of FASB**Statement No. 133*” (“SFAS No. 161”).SFAS No. 161 establishes, among other things, the disclosure requirementsfor derivative instruments and for hedging activities. SFAS No. 161 iseffective for fiscal years and interim periods beginning after November 15,2008. The Company is currently assessing the impact that SFAS No. 161 willhave on its condensed consolidated financial statements.

 

In April 2008, the FASB issued FASB staffposition (“FSP”) FAS 142-3, *Determination ofthe Useful Life of Intangible Assets* (“FSP FAS 142-3”). FSP FAS142-3 amends the factors an entity should consider in developing renewal orextension assumptions used in determining the useful life of recognizedintangible assets under FASB Statement No. 142, “Goodwill and OtherIntangible Assets”. This new guidance applies prospectively to intangibleassets that are acquired individually or with a group of other assets inbusiness combinations and asset acquisitions. FSP FAS 142-3 is effective forfinancial statements issued for fiscal years and interim periods beginningafter December 15, 2008 and as such, the Company will adopt FSP FAS 142-3on January 1, 2009. Early adoption is prohibited. The Company is currentlyevaluating the impact, if any, that FSP FAS 142-3 will have on its consolidatedfinancial statements.

 

**Item 3. Quantitativeand 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.

 

*Interest Rate Sensitivity*

 

To reduce the exposure associated with ourvariable rate debt, we entered into two interest-rate swap agreements to reduceinterest rate risks and to manage interest expense. By entering into theseagreements, we change the fixed/variable interest-rate mix of our debtportfolio. As of June 30, 2008, the interest rate swaps had notionalamounts of $280,500 and a fair value liability of $9,580. 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 7.29% during the six months ended June 30, 2008.A hypothetical, instantaneous increase of one percentage point in the interestrates applicable to the variable interest rate debt would have increased ournet interest expense for the six months ended June 30, 2008 byapproximately $1,726.

 

*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 June 30, 2008, we had translationexposure to various foreign currencies including the Euro, Pounds Sterling,Canadian Dollar, and a limited number of other non-U.S. dollars currencies. Thepotential loss resulting from a hypothetical 10% adverse change in quotedforeign currency exchange rates, as of June 30, 2008, amounts to $1,791.

 

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

 

37

----

Table of Contents

 

**Item 4. Controlsand Procedures**

 

**(a)****                                 Evaluationof Disclosure 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”)as of June, 30, 2008, 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 June 30,2008 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 June 30,2008 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 ourconsolidated financial statements. However, during the ordinary course ofbusiness, we are, from time to time, threatened with, or may become a party to,legal actions and other proceedings.

 

**Item 1A. RiskFactors**

 

There havebeen no material changes to the risk factors previously disclosed in Item 1A “RiskFactors” of the Annual  Report on Form 10-K.

 

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

 

On January 2, 2008 we issued 2,500shares of restricted stock to one of our directors. On March 13, 2008, weissued a total of 4,000 shares of restricted stock to two of our directors.

 

On January 25, 2008, we granted1,563,500 options to our employees immediately prior to the consummation of ourinitial public offering, including an aggregate of 1,031,500 options related to2007 compensation for certain employees and an aggregate of 532,000 options toall full time employees, representing a one-time grant of 500 options to eachof our employees.

 

On January 30, 2008, we completed ourinitial public offering of 16,100,000 shares of our common stock, whichincluded 4,035,816 shares sold by our selling stockholder pursuant to ourRegistration Statement on Form S-1, as amended (Reg. No. 333-146167)that was declared effective on January 24, 2008. We did not receive anyproceeds from the sale of the shares by the selling stockholders. Our netproceeds from the offering were $193.9 million, after deductingunderwriting discounts and commissions and approximately $3.5 million ofoffering expenses.

 

In January 2008, we utilized a portionof proceeds from the initial public offering to prepay the entire outstandingindebtedness under the second loan lien credit facility which amounted to$125.0 million and a 1% prepayment penalty fee, or $1.25 million. Theremainder of proceeds from the initial public offering will be utilized forgeneral corporate purposes, including working capital.

 

**Item 3. Defaults UponSenior Securities**

 

None.

 

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

 

TheCompany’s annual meeting of shareholders was held on June 4th, 2008 in NewYork,  New York, and at such meeting the shareholder considered and votedupon the following:

 

38

----

Table of Contents

 

----

(1)          The election of ten (10) directors to serve for one-year terms.

 

Thevotes were cast for this matter as follows:

 
| ** **                | ** ** | **FOR**    | ** ** | **AGAINST/ABSTAIN** | ** ** |
|---------------------------|------------|------------|------------|---------------------|------------|
| ** **                | ** ** | ** ** | ** ** | ** **          | ** ** |
| Ethan Berman              |       | 53,817,705 |       | 16,968              |       |
| Lovida  Coleman, Jr. |       | 53,454,616 |       | 380,057             |       |
| Philip Duff               |       | 53,698,342 |       | 136,331             |       |
| Rene Kern                 |       | 53,788,917 |       | 45,756              |       |
| Arthur Levitt             |       | 53,550,043 |       | 284,630             |       |
| Christopher Mitchell      |       | 53,699,061 |       | 135,612             |       |
| Frank Noonan              |       | 53,794,342 |       | 40,331              |       |
| Stephen Thieke            |       | 53,793,797 |       | 40,876              |       |
| Robert Trudeau            |       | 53,698,837 |       | 135,836             |       |
| Lynn Sharp Paine          |       | 53,798,655 |       | 36,018              |       |

 

Eachnominee was elected a Director of the Company.

 

(2) To ratify the appointment of Deloitte & Touche LLP as the Company’sindependent auditor for the fiscal year ending December 31, 2008.

 

Thevotes were cast for this matter as follows:

 
| ** ** | ** ** | **FOR**    | ** ** | **AGAINST/ABSTAIN** | ** ** |
|------------|------------|------------|------------|---------------------|------------|
| ** ** | ** ** | ** ** | ** ** | ** **          | ** ** |
|       |       | 53,705,615 |       | 129,058             |       |

 

Theselection of Deloitte & Touche LLP as the Company’s independentauditor for the fiscal year ending December 31, 2008 was ratified.

 

(3) To approve three advisory (non-binding) proposals concerning the Company’sexecutive compensation philosophy, 2007 compensation decisions, and 2008performance objectives.

 

Thevotes were cast for these matters as follows:

 
| ** **                  | ** ** | **FOR**    | ** ** | **AGAINST/ABSTAIN** | ** ** |
|-----------------------------|------------|------------|------------|---------------------|------------|
| ** **                  | ** ** | ** ** | ** ** | ** **          | ** ** |
| Compensation Philosophy     |       | 50,641,672 |       | 3,173,596           |       |
| 2007 Compensation Decisions |       | 50,712,533 |       | 3,122,140           |       |
| 2008 Performance Objectives |       | 50,645,018 |       | 3,170,250           |       |

 

Thethree advisory proposals were approved.

 

**Item 5. OtherInformation**

 

None.

 

39

----

Table of Contents

 

**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* |

 

----

*                                         Filedherewith.

 

40

----

Table of Contents

 

**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 8th day of August, 2008.

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

 

41

----