**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

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

 

**For thequarterly period ended March 31, 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 Friday, May 9, 2008 was:

 

| **Class**                   | ** ** | **Outstanding** |
|-----------------------------|------------|-----------------|
| Common stock $.01 par value |       | 60,512,639      |

 

 

----

 

**RiskMetricsGroup**

**Indexto Form 10-Q**

 

**Tableof Contents**

 
| **PART I – FINANCIAL INFORMATION** | ** **           |
|----------------------------------------------|----------------------|
| ** **                                   | **Page Number** |
| Item 1                                  | —               | Financial Statements |   |
|                                         |                 | Condensed Consolidated Financial Statements as of December 31,  2007 and March 31, 2008 and for the three Months ended March 31,  2007 and 2008: |   |
| ** **                                   | ** **           | Condensed Consolidated Balance Sheets | 2 |
|                                         |                 | Condensed Consolidated Statements of Income | 3 |
|                                         |                 | Condensed Consolidated Statements of Changes in Stockholders’ Equity | 4 |
|                                         |                 | Condensed Consolidated Statements of Cash Flows | 5 |
|                                         |                 | Notes to Condensed Consolidated Financial  Statements | 6 |
| Item 2                                  | —               | Management’s Discussion and Analysis of  Financial Condition and Results of Operations | 20 |
| Item 3                                  | —               | Quantitative and Qualitative Disclosures  About Market Risk | 34 |
| Item 4                                       | -                    | Controls and Procedures | 35 |
|                                         |                 |   |   |
| **PART II  – OTHER INFORMATION**   | ** **           |
| Item 1                                       | –               | Legal Proceedings | 36 |
| Item 1A—Risk Factors               | 36                   |
| Item 2                                       | –               | Unregistered Sales of Equity Securities and  Use of Proceeds | 36 |
| Item 3                                  | –               | Defaults Upon Senior Securities | 36 |
| Item 4                                  | —               | Submission of Matters to a Vote of Security  Holders | 36 |
| Item 5                                  | –               | Other Information | 36 |
| Item 6                                  | —               | Exhibits | 36 |

 

1

----

 

**RISKMETRICSGROUP, INC.**

 

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(Inthousands, except share amounts)**

 
| ** **                                                                                                                                                                                                                                                                              | ** ** | **December 31,  2007** | ** ** | **March 31,  2008** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|--------------------------|------------|
| ** **                                                                                                                                                                                                                                                                              | ** ** | **(unaudited)**             | ** ** | **(unaudited)**          | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                                              | ** ** | ** **                  | ** ** | ** **               | ** ** |
| CURRENT ASSETS:                                                                                                                                                                                                                                                                         |       |                        |       |                     |       |
| Cash and cash equivalents                                                                                                                                                                                                                                                               |       | $                           | 27,455     |                     | $          | 87,347 |   |
| Accounts receivable, net                                                                                                                                                                                                                                                                |       | 37,010                      |       | 56,284                   |       |
| Deferred tax asset                                                                                                                                                                                                                                                                      |       | 140                         |       | 140                      |       |
| Income taxes receivable                                                                                                                                                                                                                                                                 |       | 8,300                       |       | 10,681                   |       |
| Other receivables and prepaid expenses                                                                                                                                                                                                                                                  |       | 5,910                       |       | 6,184                    |       |
| Total current assets                                                                                                                                                                                                                                                                    |       | 78,815                      |       | 160,636                  |       |
| Intangibles—net                                                                                                                                                                                                                                                                    |       | 174,154                     |       | 168,698                  |       |
| Goodwill                                                                                                                                                                                                                                                                                |       | 460,951                     |       | 460,355                  |       |
| Property and equipment—net                                                                                                                                                                                                                                                         |       | 16,225                      |       | 15,890                   |       |
| Deferred financing costs                                                                                                                                                                                                                                                                |       | 8,677                       |       | 6,007                    |       |
| Other assets                                                                                                                                                                                                                                                                            |       | 4,361                       |       | 1,744                    |       |
| TOTAL ASSETS                                                                                                                                                                                                                                                                            |       | $                           | 743,183    |                     | $          | 813,330 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                                           |       |                        |       |                     |       |
| CURRENT LIABILITIES:                                                                                                                                                                                                                                                                    |       |                        |       |                     |       |
| Trade accounts payable                                                                                                                                                                                                                                                                  |       | $                           | 6,235      |                     | $          | 3,462 |   |
| Accrued expenses                                                                                                                                                                                                                                                                        |       | 34,189                      |       | 20,399                   |       |
| Debt, current portion                                                                                                                                                                                                                                                                   |       | 3,000                       |       | 6,381                    |       |
| Deferred revenue, current portion                                                                                                                                                                                                                                                       |       | 100,557                     |       | 111,783                  |       |
| Other current liabilities                                                                                                                                                                                                                                                               |       | 227                         |       | 247                      |       |
| Total current liabilities                                                                                                                                                                                                                                                               |       | 144,208                     |       | 142,272                  |       |
| LONG-TERM LIABILITIES                                                                                                                                                                                                                                                                   |       |                        |       |                     |       |
| Debt                                                                                                                                                                                                                                                                                    |       | 419,750                     |       | 290,619                  |       |
| Deferred tax liabilities                                                                                                                                                                                                                                                                |       | 28,626                      |       | 24,889                   |       |
| Deferred revenue                                                                                                                                                                                                                                                                        |       | 722                         |       | 551                      |       |
| Other long-term liabilities                                                                                                                                                                                                                                                             |       | 13,785                      |       | 21,846                   |       |
| Total liabilities                                                                                                                                                                                                                                                                       |       | 607,091                     |       | 480,177                  |       |
|                                                                                                                                                                                                                                                                                    |       |                        |       |                     |       |
| COMMITMENTS AND CONTINGENCIES                                                                                                                                                                                                                                                           |       |                        |       |                     |       |
|                                                                                                                                                                                                                                                                                    |       |                        |       |                     |       |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                                                                                                                              |       |                        |       |                     |       |
| Common stock, $.01 par value—150,000,000  and 200,000,000 authorized at December 31, 2007 and March 31, 2008,  respectively; 47,850,652 and 60,716,514 issued and 47,642,460 and 60,508,322  outstanding at December 31, 2007 and March 31, 2008, respectively |       | 479                         |       | 607                      |       |
| Treasury stock—208,192 shares                                                                                                                                                                                                                                                      |       | (2                          | )          | (2                       | )          |
| Additional paid-in capital                                                                                                                                                                                                                                                              |       | 217,355                     |       | 418,618                  |       |
| Accumulated other comprehensive loss                                                                                                                                                                                                                                                    |       | (7,262                      | )          | (11,939                  | )          |
| Accumulated deficit                                                                                                                                                                                                                                                                     |       | (74,478                     | )          | (74,131                  | )          |
| Total stockholders’ equity                                                                                                                                                                                                                                                         |       | 136,092                     |       | 333,153                  |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                                                                                                         |       | $                           | 743,183    |                     | $          | 813,330 |   |

 

See notes tocondensed consolidated financial statements (unaudited).

 

2

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**RISKMETRICSGROUP, INC.**

 

**CONDENSED CONSOLIDATED STATEMENTS OF INCOME**

**FORTHE THREE MONTHS ENDED MARCH 31, 2007 AND 2008**

** **

**(UNAUDITED)**

 

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

 
| ** **                                                                                                                 | ** ** | **2007**   | ** ** | **2008**   | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| REVENUES                                                                                                                   |       | $          | 52,365     |       | $          | 71,220 |   |
| OPERATING COSTS AND EXPENSES:                                                                                              |       |       |       |       |       |
| Cost of revenues (including stock-based  compensation of $192 and $1,558 in 2007 and 2008, respectively)                   |       | 16,593     |       | 22,704     |       |
| Research and development expenses  (including stock-based compensation of $199 and $781 in 2007 and 2008,  respectively)   |       | 6,879      |       | 10,461     |       |
| Selling and marketing expenses (including  stock-based compensation of $107 and $321 in 2007 and 2008, respectively)       |       | 8,093      |       | 9,206      |       |
| General and administrative expenses  (including stock-based compensation of $298 and $701 in 2007 and 2008,  respectively) |       | 6,519      |       | 9,205      |       |
| Depreciation and amortization of property  and equipment                                                                   |       | 1,584      |       | 2,115      |       |
| Amortization of intangible assets                                                                                          |       | 4,189      |       | 5,456      |       |
| Loss on disposal of fixed assets                                                                                           |       | —     |       | 22         |       |
| Total operating costs and expenses                                                                                         |       | 43,857     |       | 59,169     |       |
| INCOME FROM OPERATIONS                                                                                                     |       | 8,508      |       | 12,051     |       |
|                                                                                                                       |       |       |       |       |       |
| INTEREST, DIVIDEND, INVESTMENT, AND OTHER  INCOME (EXPENSE), NET:                                                          |       |       |       |       |       |
|                                                                                                                       |       |       |       |       |       |
| Interest, dividend and investment income                                                                                   |       | 586        |       | 299        |       |
| Interest expense (Note 7)                                                                                                  |       | (8,490     | )          | (9,163     | )          |
| Other expenses (Note 7)                                                                                                    |       | —     |       | (2,613     | )          |
| Total interest, dividend, investment, and  other income (expense), net                                                     |       | (7,904     | )          | (11,477    | )          |
| INCOME BEFORE PROVISION FOR INCOME TAXES                                                                                   |       | 604        |       | 574        |       |
| PROVISION FOR INCOME TAXES                                                                                                 |       | 315        |       | 227        |       |
| NET INCOME                                                                                                                 |       | $          | 289        |       | $          | 347 |   |
| INCOME PER SHARE:                                                                                                          |       |       |       |       |       |
| Basic                                                                                                                      |       | $          | 0.01       |       | $          | 0.01 |   |
| Diluted                                                                                                                    |       | $          | 0.01       |       | $          | 0.01 |   |
|                                                                                                                       |       |       |       |       |       |
| WEIGHTED AVERAGE NUMBER OF COMMON SHARES  OUTSTANDING:                                                                     |       |       |       |       |       |
|                                                                                                                       |       |       |       |       |       |
| Basic                                                                                                                      |       | 45,016,364 |       | 57,161,701 |       |
| Diluted                                                                                                                    |       | 53,377,084 |       | 64,811,753 |       |

 

See notes tocondensed consolidated financial statements (unaudited).

 

3

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**RISKMETRICSGROUP, INC.**

 

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

**FORTHE THREE MONTHS ENDED MARCH 31, 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                                                                                                               |       | —                                 |       | —     |       | —              |       | —                 |       | —                  |       | 347                      |       | 347 |   |
| Foreign currency  translation adjustment                                                                                 |       | —                                 |       | —     |       | —              |       | —                 |       | (32                     | )          | —                   |       | (32 | ) |
| Net unrealized  loss on cash flow hedge, net of deferred tax benefit of $3,309 and realized  loss (see disclosure below) |       | —                                 |       | —     |       | —              |       | —                 |       | (4,645                  | )          | —                   |       | (4,645 | ) |
| Total  comprehensive loss                                                                                                |       | —                                 |       | —     |       | —              |       | —                 |       | —                  |       | —                   |       | (4,330 | ) |
|                                                                                                                     |       |                                   |       |       |       |                |       |                   |       |                    |       |                     |       |   |   |
| Common shares issued  upon exercise of options                                                                           |       | 761,099                                |       | 8          |       | —              |       | 2,674                  |       | —                  |       | —                   |       | 2,682 |   |
| Tax benefit  associated with exercise of stock options                                                                   |       | —                                 |       | —     |       | —              |       | 1,458                  |       | —                  |       | —                   |       | 1,458 |   |
| Stock-based  compensation                                                                                                |       | —                                 |       | —     |       | —              |       | 3,361                  |       | —                  |       | —                   |       | 3,361 |   |
| –Issuance of  stock (Note 11)                                                                                       |       | 40,579                                 |       | —     |       | —              |       | —                 |       | —                  |       | —                   |       | — |   |
| Net proceeds from  equity offering (Note 3)                                                                              |       | 12,064,184                             |       | 120        |       | —              |       | 193,770                |       | —                  |       | —                   |       | 193,890 |   |
|                                                                                                                     |       |                                   |       |       |       |                |       |                   |       |                    |       |                     |       |   |   |
| BALANCE—March 31,  2008                                                                                        |       | 60,716,514                             |       | $          | 607        |                | $          | (2                     | )          | $                       | 418,618    |                     | $          | (11,939 | ) | $ | (74,131 | ) | $ | 333,153 |   |
|                                                                                                                     |       |                                   |       |       |       |                |       |                   |       |                    |       |                     |       |   |   |
| Disclosure of  realized loss:                                                                                            |       |                                   |       |       |       |                |       |                   |       |                    |       |                     |       |   |   |
| Unrealized loss  on cash flow hedge                                                                                      |       | $                                      | (5,470     | )          |       |                |       |                   |       |                    |       |                     |       |   |   |   |
| Realized loss for  cash flow hedge settlement , net of tax benefit of $539 (Note 8)                                      |       | 825                                    |       |       |       |                |       |                   |       |                    |       |                     |       |   |   |
| Net unrealized  loss on cash flow hedge                                                                                  |       | $                                      | (4,645     | )          |       |                |       |                   |       |                    |       |                     |       |   |   |   |

 

See notes tocondensed consolidated financial statements (unaudited).

 

4

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**RISKMETRICSGROUP, INC.**

 

**CONDENSED CONSOLIDATED STATEMENTS OF CASHFLOWS**

**FORTHE THREE MONTHS ENDED MARCH 31, 2007 AND 2008**

 

**(UNAUDITED)**

 

**(Amountsin thousands)**

 
| ** **                                                                                                                                            | ** ** | **2007**   | ** ** | **2008**   | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                                                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                                                                                       |       | $          |  289  |       | $          |  347 |   |
| Adjustments to reconcile net income to net  cash used by operating activities:                                                                        |       |       |       |       |       |
| Depreciation and amortization of property  and equipment                                                                                              |       | 1,584      |       | 2,115      |       |
| Provision for bad debt                                                                                                                                |       | 166        |       | 176        |       |
| Amortization of intangible assets                                                                                                                     |       | 4,189      |       | 5,456      |       |
| Amortization of debt issuance costs                                                                                                                   |       | 349        |       | 2,670      |       |
| Stock-based compensation                                                                                                                              |       | 796        |       | 3,361      |       |
| Tax benefit associated with exercise of  stock options                                                                                                |       | —     |       | (1,458     | )          |
| Loss on disposal of fixed assets                                                                                                                      |       | —     |       | 22         |       |
| Changes in assets and liabilities:                                                                                                                    |       |       |       | —     |       |
| (Increase) decrease in accounts receivable                                                                                                            |       | 4,924      |       | (19,550    | )          |
| Increase in other receivables and prepaid  expenses                                                                                                   |       | (334       | )          | (264       | )          |
| (Increase) decrease in other assets                                                                                                                   |       | 590        |       | (54        | )          |
| Increase (decrease) in deferred revenue                                                                                                               |       | (2,187     | )          | 11,062     |       |
| Increase in income taxes receivable                                                                                                                   |       | (1,026     | )          | (632       | )          |
| Decrease in trade accounts payable                                                                                                                    |       | (799       | )          | (2,828     | )          |
| Decrease in other accrued expenses and  liabilities                                                                                                   |       | (16,601    | )          | (13,362    | )          |
| Net cash used by operating activities                                                                                                                 |       | (8,060     | )          | (12,939    | )          |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                                                                                 |       |       |       |       |       |
| Purchase of property and equipment                                                                                                                    |       | (2,074     | )          | (1,777     | )          |
| Cash paid to acquire Institutional  Shareholder Services Inc. (“ISS”) and related acquisition costs (net of  cash acquired of $12,250) |       | (471,764   | )          | —     |       |
| Payment of acquired ISS acquisition related  costs                                                                                                    |       | (7,413     | )          | —     |       |
| Proceeds from sale of investments                                                                                                                     |       | 59,575     |       | —     |       |
| Net cash used in investing activities                                                                                                                 |       | (421,676   | )          | (1,777     | )          |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                                                                                 |       | —     |       |       |       |
| Proceeds from debt borrowings                                                                                                                         |       | 425,000    |       | —     |       |
| Repayment of debt                                                                                                                                     |       | —     |       | (125,750   | )          |
| Payment of debt issuance costs                                                                                                                        |       | (10,074    | )          | —     |       |
| Principal payments on capital lease  obligations                                                                                                      |       | (5         | )          | —     |       |
| Gross proceeds from equity offering (Note  3)                                                                                                         |       | —     |       | 197,400    |       |
| Equity offering expenses                                                                                                                              |       |       |       | (1,073     | )          |
| Excess tax benefit associated with exercise  of stock options                                                                                         |       |       |       | 1,458      |       |
| Proceeds from exercise of stock options                                                                                                               |       | 55         |       | 2,682      |       |
| Net cash provided by financing activities                                                                                                             |       | 414,976    |       | 74,717     |       |
| EFFECT OF EXCHANGE RATE CHANGES ON CASH                                                                                                               |       | 115        |       | (109       | )          |
| NET INCREASE (DECREASE) IN CASH AND CASH  EQUIVALENTS                                                                                                 |       | (14,645    | )          | 59,892     |       |
| CASH AND CASH EQUIVALENTS—Beginning of year                                                                                                      |       | 37,313     |       | 27,455     |       |
| CASH AND CASH EQUIVALENTS—End of year                                                                                                            |       | $          | 22,668     |       | $          | 87,347 |   |
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW  INFORMATION:                                                                                                   |       |       |       |       |       |
| Cash paid for interest                                                                                                                                |       | $          | 7,913      |       | $          | 6,472 |   |
| Cash paid for taxes (net of refunds)                                                                                                                  |       | $          | 281        |       | $          | 1,651 |   |
| 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                                                                                            |       | —     |       | $          | 596        |   |

 

See notes tocondensed consolidated financial statements (unaudited).

 

5

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**RISKMETRICSGROUP, INC.**

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

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

 

**(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.

 

The condensed consolidated financialstatements as of March 31, 2008 and for the three months ended March 31,2007 and 2008 have not been audited, but in the opinion of management, alladjustments, consisting only of normal recurring accruals, have been made topresent fairly the Company’s financial position, results of operations and cashflows. The operating results for the three months ended March 31, 2008 arenot necessarily indicative of the results to be expected for the full year. Thefinancial statements and related notes have been prepared on the same basis asand should be read in conjunction with the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2007.  The December 31, 2007 consolidated financial statement informationhas been derived from the 2007 audited consolidated financial statements.

 

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

 

***Significant Accounting Policies****—*The preparation of condensed consolidated financialstatements in conformity with accounting principles generally accepted withinthe United States of America requires management to make estimates, judgmentsand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the condensedconsolidated financial statements and the reported amounts of revenues andexpenses during the reporting period. Significantestimates and assumptions made by management include the deferral andrecognition of revenue, impairment of goodwill and intangible assets,stock-based compensation, 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. The Companyadopted SFAS 157 on January 1, 2008 and such adoption did not have amaterial impact on the condensed consolidated financial statements.  Refer to 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 measuring relatedassets and liabilities differently. Accounting principles generally acceptedwithin the United States have required different measurement attributes fordifferent assets and liabilities that can create artificial volatility inearnings. SFAS 159 helps to mitigate this type of accounting-inducedvolatility by enabling companies to report related assets and liabilities atfair value, which would likely reduce the need for companies to comply withdetailed rules for hedge accounting. SFAS 159 also establishespresentation and disclosure requirements designed to facilitate comparisonsbetween companies that choose different measurement attributes for similartypes of asset and liabilities. SFAS 159 requires 

 

6

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**RISKMETRICSGROUP, INC.**

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**FOR THE THREE MONTHS ENDED MARCH 31,2008**

 

companies to provide additional information that will help investorsand other users of financial statements to more easily understand the effect ofthe Company’s choice to use fair value on its earnings. It also requiresentities to display the fair value of these assets and liabilities for whichthe Company has chosen to use fair value on the face of the balance sheet. TheCompany adopted SFAS 159 on January 1, 2008 and such adoption did nothave an impact on the condensed 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 and noncontrolling(or minority) interests in consolidated financial statements. SFAS 141(R) isrequired to be adopted concurrently with Statement No. 160 and iseffective for business combination transactions for which the acquisition dateis on or after the beginning of the first annual reporting period beginning onor after December 15, 2008. Early adoption is prohibited. Application ofSFAS 141(R) and SFAS 160 is required to be adoptedprospectively, except for certain provisions of SFAS 160, which arerequired to be adopted retrospectively. Business combination transactionsaccounted for before adoption of SFAS 141(R) should be accounted forin accordance with Statement No. 141 and that accounting previouslycompleted under Statement No. 141 should not be modified as of or afterthe date of adoption of Statement No.141(R). The adoption of SFAS 141 (R) andSFAS 160 is not expected to have a material impact on the Company’sfinancial position or results of operations.

 

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.

 

**3.  INITIAL PUBLIC OFFERING**

 

In January 2008, the Company completedan initial public offering of 14,000,000 shares of common stock, which included4,035,816 shares sold by selling stockholders. The Company did not receive anyproceeds from the sale of the shares by the selling stockholders. In addition,the Company granted the underwriters an option to purchase a maximum of2,100,000 additional shares of common stock to cover over-allotments, which wasexercised in full in January 2008. Net proceeds from the offering,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 $1.1 millionwere paid during the three months ended March 31, 2008.   The Company utilized a portion of theproceeds to prepay the entire outstanding indebtedness under the Company’s secondloan lien credit facility (See Note 7).

 

**4. ACQUISITIONS**

 

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 consideration                                                           |   | $      | 542,771 |   |

 

7

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**RISKMETRICSGROUP, INC.**

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**FOR THE THREE MONTHS ENDED MARCH 31, 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 converted stock optionsissued in connection 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 employee rolloveroptions are exercised. As such exercises occur, the Company recognizes a taxdeduction and such benefit is recorded as a reduction of goodwill (Note 5).

 

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 |         |
|                   |   | $       | 172,339 |                          |         |   |

 

8

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**RISKMETRICSGROUP, INC.**

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**FOR THE THREE MONTHS ENDED MARCH 31,2008**

 

*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.

 

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    |   |
| Total purchase consideration                           |   | $      | 63,793 |   |

 

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:

 
| Cash and other current assets         |   | $      | 3,104  |   |
|---------------------------------------|--------|--------|--------|--------|
| Property and equipment                |   | 511    |   |
| Non-current assets                    |   | 49     |   |
| Intangible assets                     |   | 19,710 |   |
| Goodwill                              |   | 46,097 |   |
| Total assets acquired                 |   | 69,471 |   |
| Accounts payable and accrued expenses |   | (1,887 | )      |
| Deferred revenue                      |   | (3,791 | )      |
| Net assets acquired                   |   | $      | 63,793 |   |
| Goodwill                              |   | 46,097 |   |
| Identifiable intangible assets        |   | 19,710 |   |
| Net liabilities assumed               |   | (2,014 | )      |
| Total purchase consideration          |   | $      | 63,793 |   |

 

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 intangibles       |   | $     | 19,710 |         |         |   |

 

The following table summarizes unaudited proforma financial information for the three months ended March 31, 2007assuming the acquisitions of ISS and CFRA had occurred on January 1, 2007.

 
| ** **           | ** ** | **Three Months Ended  March 31, 2007** | ** ** |
|----------------------|------------|------------------------------------------------------------|------------|
| Revenues             |       | $                                                          | 59,620     |   |
| Loss from operations |       | (6,120                                                     | )          |
| Net loss             |       | (8,882                                                     | )          |
| Net loss per share:  |       |                                                       |       |
| Basic and diluted    |       | $                                                          | (0.20      | ) |

 

9

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**RISKMETRICSGROUP, INC.**

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**FOR THE THREE MONTHS ENDED MARCH 31,2008**

 

Included in pro forma loss from operationsfor the three months ended March 31, 2007 are $13.4 million ofnon-recurring expenses incurred by ISS in connection with its acquisition byRMG, which were for prior services rendered and a $1.2 millionnon-recurring charge associated with the pre-existing indebtedness of ISS, allof which will have no continuing impact on the Company’s financial statements.These unaudited pro forma results are intended for informational purposes onlyand are not necessarily indicative of the results of operations that would haveoccurred had the ISS and CFRA acquisitions been in effect at the beginning ofthe periods presented, or of future results of the combined operations.

 

**5. INTANGIBLE ASSETS AND GOODWILL**

 

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

 
| ** **              | ** ** | **December 31, 2007** | ** ** |
|-------------------------|------------|---------------------------------|------------|
| ** **              | ** ** | **Useful Lives**           | ** ** | **Gross** | ** ** | **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 |   |

 
| ** **              | ** ** | **March 31, 2008** | ** ** |
|-------------------------|------------|------------------------------|------------|
| ** **              | ** ** | **Useful Lives**        | ** ** | **Gross** | ** ** | **Amortization** | ** ** | **Net** | ** ** |
| Customer relationships  |       | 7–11 years         |       | $ | 128,150 |   | $ | 14,402 |   | $ | 113,748 |   |
| Acquired technology     |       | 5 years                 |       | 25,279 |   | 6,142 |   | 19,137 |   |
| Covenant not to compete |       | 1–3 years          |       | 1,500 |   | 375 |   | 1,125 |   |
| Proprietary process     |       | 7 years                 |       | 8,870 |   | 845 |   | 8,025 |   |
| Trade names             |       | 1–10 years         |       | 22,800 |   | 2,837 |   | 19,963 |   |
| Trade names             |       | Indefinite                   |       | 6,700 |   | — |   | 6,700 |   |
| Total                   |       |                         |       | $ | 193,299 |   | $ | (24,601 | ) | $ | 168,698 |   |

 

Amortization expense of intangible assets forthe three months ended March 31, 2007 and 2008, was $4,189 and $5,456,respectively, and is included in amortization of intangible assets on theconsolidated statements of income.

 

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 |   | $      | 16,223 |   |
|--------------------------------------------------|--------|--------|--------|--------|
| Years ending December 31,                   |   |   |   |
| 2009                                             |   | $      | 21,475 |   |
| 2010                                             |   | $      | 21,371 |   |
| 2011                                             |   | $      | 21,058 |   |
| 2012                                             |   | $      | 16,180 |   |

 

Goodwill changed during the three monthsended March 31, 2008 as follows:

 
| Balance at January 1, 2008                                                                      |   | $   | 460,951 |   |
|------------------------------------------------------------------------------------------------------|--------|-----|---------|--------|
| Less: Tax benefit on exercise of stock  options granted to ISS employees on acquisition (See Note 4) |   | 596 |    |
| Balance at March 31, 2008                                                                       |   | $   | 460,355 |   |

 

10

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**RISKMETRICSGROUP, INC.**

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**FOR THE THREE MONTHS ENDED MARCH 31,2008**

 

**6. ACCRUED EXPENSES**

 

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

 
| ** **                           | ** ** | **December 31,  2007** | ** ** | **March 31,  2008** | ** ** |
|--------------------------------------|------------|-----------------------------|------------|--------------------------|------------|
| Accrued compensation and related tax |       | $                           | 28,490     |                     | $          | 12,262 |   |
| Accrued data expense                 |       | 1,133                       |       | 1,732                    |       |
| Accrued travel and entertainment     |       | 227                         |       | 416                      |       |
| Accrued professional fees            |       | 1,813                       |       | 2,576                    |       |
| Current portion of deferred rent     |       | 202                         |       | 202                      |       |
| Other accrued expenses               |       | 2,324                       |       | 3,211                    |       |
|                                 |       | $                           | 34,189     |                     | $          | 20,399 |   |

 

**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 loanfacilities and 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 paid under the first lien term loan facility may not bere-borrowed. Amounts paid under the revolving credit facility may bere-borrowed. The maturity date for the revolving credit facility and first lienterm loan facility is January 2013 and 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 (Note3) to prepay the entire outstanding indebtedness under the second lien loan,which amounted to $125.0 million. In addition, the Company paid a 1%prepayment penalty fee, or $1.25 million, upon prepayment as set forth inthe credit agreement, which has been included in other expenses for the threemonths ended March 31, 2008 in the accompanying consolidated statements ofincome. In conjunction with the prepayment of the second lien loan during thethree months ended March 31, 2008, the Company reduced the notional amountof the interest rate swap by $19.3 million, which resulted in otherexpense of $1.4 million in 2008 (Note 8).

 

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 $750, ofwhich the next payment is due on June 30, 2008. Furthermore, startingafter the fiscal year ended December 31, 2007, the Company is required tomake a mandatory payment equal to 50% of each year’s excess cash flow dependingon leverage ratios, as defined in the first lien term loan facility, withinfive days of delivery of audited financial statements. In April 2008, the Company paid an excess cash flow principalpayment of $6,381 for its first lien term loan, as required by the creditfacility. The Company is required to repay the aggregate principalremaining on the first lien term loan facility on the maturity date. TheCompany may voluntarily prepay the first lien credit facilities in whole or inpart without penalty.

 

11

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**RISKMETRICSGROUP, INC.**

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**FOR THE THREE MONTHS ENDED MARCH 31,2008**

 

Scheduled repayments of balances outstandingas of March 31, 2008 are as follows:

 
| For the twelve months ending March 31, |   |    |    |
|---------------------------------------------|--------|---------|---------|
| 2009                                        |   | $       | 6,381   |   |
| 2010                                        |   | 3,000   |    |
| 2011                                        |   | 3,000   |    |
| 2012                                        |   | 3,000   |    |
| 2013                                        |   | 3,000   |    |
| Thereafter                                  |   | 278,619 |    |
|                                        |   | $       | 297,000 |   |

 

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,including such write-off, on the accompanying statement of income. Inconjunction with the prepayment of the second lien loan during the three monthsended March 31, 2008, the Company wrote-off debt issuance costs of $2,377.Amortization expense of debt issuance costs for the three months ended March 31,2007 and 2008 was $317 and $2,670, respectively and is included in interestexpense on the accompanying consolidated statements of income.

 

**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 primarilyuses the income approach, which uses valuation techniques to convert futureamounts to a single present amount. As of March 31, 2008 the Company hadinterest rate swap agreements which are valued under a level 2 input as shown inthe following table:

 
| ** **         | ** ** | ** ** | ** ** | **Fair value at March 31, 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 |       | $          | 18,952     |                                                              | $          | — |   | $ | 18,952 |   | $ | — |   |
| Total              |       | $          | 18,952     |                                                              | $          | — |   | $ | 18,952 |   | $ | — |   |

 

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 investment income (loss) of $102 and $(215)being recorded in investment income (loss) in the accompanying consolidatedstatements of income for the three months ended March 31, 2007 and 2008,respectively. The Company’s interest-rate swap agreements hedge a substantialportion of the interest rate risk exposure under the Company’s debt (seeNote 7). As of December 31, 2007 and March 31, 2008, the swapagreements had a notional amount of $317,063 and $281,063, respectively. As of December 31,2007 and March 31, 2008, the swap agreements had a fair value liability of$10,990 and $18,952, respectively, which is included in other long-termliabilities on the accompanying consolidated balance sheet.

 

In conjunction with the prepayment of the secondlien loan during the three months ended March 31, 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 three monthsended March 31, 2008.

 

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 

 

12

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**RISKMETRICSGROUP, INC.**

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**FOR THE THREE MONTHS ENDED MARCH 31,2008**

 

March 31, 2008. To the extent that the agreement is not consideredto be highly effective in offsetting the change in the value of the interestpayments being hedged, the fair value relating to the ineffective portion ofsuch agreement and any subsequent changes in such fair value will beimmediately recognized in earnings. To the extent that the agreement isconsidered highly effective but not completely effective in offsetting thechange in the value of the interest payments being hedged, any changes in fairvalue relating to the ineffective portion of such agreement will be immediatelyrecognized in earnings. Effective gains and losses have been included in theunrealized gain on cash flow hedges as a component of other comprehensiveincome (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 thethree months ended March 31, 2007 and 2008 as follows:

 
| ** **                                                               | ** ** | **Three months ended  March 31,** | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                               | ** ** | **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                                             | )%         | 5.5 | % |
| Non-deductible stock option expense under  SFAS 123(R)              |       | 31.3                                             | %          | 1.9 | % |
| Other                                                                    |       | (10.8                                            | )%         | (2.9 | )% |
| Net tax provision                                                        |       | 52.2                                             | %          | 39.5 | % |

 

Other is primarily comprised of foreign tax credits, research anddevelopment credits and foreign income differentials and has declined due to areduction in research and development credits and increased projected pre-taxincome.

 

*FIN 48*

 

As of March 31, 2008, the Company’sunrecognized tax benefits totaled $1,267, of which $534 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 nine months,an increase of $234 will be recorded for unrecognized tax benefits and suchincrease will unfavorably impact the Company’s income tax provision.

 

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. As of March 31,2008, $264 was accrued for the payment of interest and penalties.

 

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 |   | 74     |   |
| Additions for tax positions of prior years                    |   | 4      |   |
| Reductions for tax positions of prior years                   |   | — |   |
| Balance at March 31, 2008                                |   | $      | 1,267  |   |

 

**10. COMMITMENTS AND CONTINGENCIES**

 

The Company is committed to unrelated partiesfor the rental of office space under operating leases. As of March 31,2008, minimum future rental payments under operating leases are as follows:

 

13

----

 

**RISKMETRICSGROUP, INC.**

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**FOR THE THREE MONTHS ENDED MARCH 31,2008**

 
| For the twelve months ending March 31, |   |   |   |
|---------------------------------------------|--------|--------|--------|
| 2009                                        |   | $      | 6,210  |   |
| 2010                                        |   | 6,495  |   |
| 2011                                        |   | 5,706  |   |
| 2012                                        |   | 5,372  |   |
| 2013                                        |   | 2,672  |   |
| Thereafter                                  |   | 588    |   |
| Total minimum lease payments                |   | $      | 27,043 |   |

 

Duringthe three months ended March 31, 2008, the Company incurred a $198 leaseexit cost as a result of moving the Company’s London operations and suchexpense has been included in general and administrative expenses in theaccompanying statement of income.

 

***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 March 31, 2008, are as follows:

 
| For the twelve months ending March 31, |   |   |   |
|---------------------------------------------|--------|--------|--------|
| 2009                                        |   | $      | 5,886  |   |
| 2010                                        |   | 2,206  |   |
| 2011                                        |   | 585    |   |
| Total                                       |   | $      | 8,677  |   |

 

***Contingencies***—TheCompany has no lawsuits against it that it deems to be material nor has theCompany initiated any against any others. The Company believes that anypotential liability arising from known or unknown actions or claims will nothave a material adverse effect on the Company’s consolidated results of income,financial condition, or liquidity

 

**11. STOCK BASED COMPENSATION**

 

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

 

*Stock Options*

 

During 2000, the Company’s Board of Directorsadopted a Stock Option Plan (the “2000 Plan”) that provided for the grant ofoptions to employees, consultants, and non-employee directors to purchasecommon stock, which vest over a one to four year period and have a ten-yearcontractual term. The maximum number of shares of the Company’s common stockavailable for issuance under the 2000 Plan was 12,500,000, and no more than4,000,000 were allowed to be issued in any calendar year. The Company retiredthe 2000 Plan and adopted a new option plan (the “2004 Plan”). As of March 31,2008, 6,255,846 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-year contractualterm. To satisfy options granted under the Plan, the Company may make commonstock available from authorized but unissued shares or shares held in treasuryby the Company. The maximum number of shares of the Company’s common stockavailable for issuance under the 2004 Plan is 7,500,000. Subsequent to theacquisition of ISS, the Company retired the 2004 plan and adopted a new optionplan (the “2007 plan”). As of March 31, 2008, 4,596,395 options issuedunder 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 March 31, 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 

 

14

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**RISKMETRICSGROUP, INC.**

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**FOR THE THREE MONTHS ENDED MARCH 31,2008**

 

common stock available for issuance under the 2007 Plan is 6,500,000.As of March 31, 2008, 3,114,352 options issued and 312,530 shares ofnon-vested stock granted under the 2007 Plan remain outstanding.

 

15

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**RISKMETRICSGROUP, INC.**

 

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**FORTHE THREE MONTHS ENDED MARCH 31, 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*                              |       | 1,613,500                  |       | $                                       | 17.50      |   |
| Exercised                             |       | (761,099                   | )          | $                                       | 3.52       |   |
| Forfeited                             |       | (83,348                    | )          | $                                       | 14.02      |   |
| Outstanding—March 31, 2008  |       | 14,130,335                 |       | $                                       | 7.21       |   |

 

----

*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 50,000 options to a newly hiredemployee on March 18, 2008.

 

The Company’s stock options outstanding at March 31,2008 were as follows:

 
| ** **           | ** ** | **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  |                                                                | 2.83       |   | $ | 1.20 |   | 1,069,458 |   | $ | 1.20 |   |
| 1.48                 |       | 85,799                       |       | 3.69                                                                |       | 1.48 |   | 85,799 |   | 1.48 |   |
| 2.00                 |       | 3,251,232                    |       | 4.50                                                                |       | 2.00 |   | 3,251,230 |   | 2.00 |   |
| 2.33                 |       | 4,505                        |       | 4.91                                                                |       | 2.33 |   | 4,505 |   | 2.33 |   |
| 2.40                 |       | 1,935,156                    |       | 5.76                                                                |       | 2.40 |   | 1,909,185 |   | 2.40 |   |
| 3.42                 |       | 20,365                       |       | 5.59                                                                |       | 3.42 |   | 20,365 |   | 3.42 |   |
| 3.75                 |       | 243,125                      |       | 6.43                                                                |       | 3.75 |   | 202,188 |   | 3.75 |   |
| 4.46                 |       | 15,141                       |       | 6.52                                                                |       | 4.46 |   | 15,141 |   | 4.46 |   |
| 4.80                 |       | 1,279,270                    |       | 6.78                                                                |       | 4.80 |   | 927,398 |   | 4.80 |   |
| 5.05                 |       | 17,837                       |       | 7.11                                                                |       | 5.05 |   | 17,837 |   | 5.05 |   |
| 5.94                 |       | 20,095                       |       | 7.87                                                                |       | 5.94 |   | 20,095 |   | 5.94 |   |
| 6.00                 |       | 243,750                      |       | 7.35                                                                |       | 6.00 |   | 125,212 |   | 6.00 |   |
| 7.20                 |       | 1,758,423                    |       | 7.83                                                                |       | 7.20 |   | 801,681 |   | 7.20 |   |
| 15.29                |       | 2,416,421                    |       | 8.93                                                                |       | 15.29 |   | 609,003 |   | 15.29 |   |
| 16.50                |       | 175,758                      |       | 9.34                                                                |       | 16.50 |   | — |   | 16.50 |   |
| 17.50                |       | 1,594,000                    |       | 9.82                                                                |       | 17.50 |   | 195,000 |   | 17.50 |   |
|                 |       | 14,130,335                   |       | 6.68                                                                |       | $ | 7.21 |   | 9,254,097 |   | $ | 4.03 |   |
|                      |            |                              |            |                                                                     |            |  |  |  |  |  |  |  |  |  |

 

16

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**RISKMETRICSGROUP, INC.**

 

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**FOR THE THREE MONTHS ENDED MARCH 31,2008**

 

Of the unvested options as of March 31,2008, 4,437,377 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  March 31,** | ** ** |
|---------------------------------|------------|--------------------------------------------------|------------|
| ** **                      | ** ** | **2008**                                         | ** ** |
| Risk-free interest rate         |       | 2.6                                              | %          |
| Expected term (in years)        |       | 4.5                                              |       |
| Expected stock price volatility |       | 35                                               | %          |
| Expected dividend yield         |       | None                                             |       |

 

The weighted-average per share fair value ofoptions granted during the three months ended March 31, 2008 was $5.63.

 

*Non-vested Stock*

 

The following table summarizes non-vestedstock activity for the three months ended March 31, 2008:

 
| ** **                              | ** ** | **Number of  Shares** | ** ** | **Weighted Average  Grant Date  Fair Value** | ** ** |
|-----------------------------------------|------------|----------------------------|------------|-------------------------------------------------------------|------------|
| Unvested shares at January 1, 2008 |       | 346,609                    |       | $                                                           | 16.50      |   |
| Granted                                 |       | 6,500                      |       | 16.81                                                       |       |
| Vested                                  |       | (40,579                    | )          | 16.50                                                       |       |
| Forfeited                               |       | —                     |       |                                                        |       |
| Unvested Shares at March 31, 2008  |       | 312,530                    |       | $                                                           | 16.51      |   |

 

Share-based compensation expense was $796 and$3,361 for the three months ended March 31, 2007 and 2008, respectively.As of March 31, 2008, there was approximately $21,210 of unrecognizedcompensation costs related to stock options and non-vested share-basedcompensation awards granted under the stock option plans, which is expected tobe recognized over a period of four 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 threemonths ended March 31, 2007 and 2008, the difference between basic anddiluted number of shares outstanding is as follows:

 
| ** **                                             | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                             | ** ** | **2007**                                         | ** ** | **2008** | ** ** |
| Basic number of weighted-average shares  outstanding   |       | 45,016,364                                       |       | 57,161,701 |   |
| Effect of dilutive securities—                    |       |                                             |       |   |   |
| Employee stock options and non-vested stock            |       | 8,360,720                                        |       | 7,650,052 |   |
| Diluted number of weighted-average shares  outstanding |       | 53,377,084                                       |       | 64,811,753 |   |

 

17

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**RISKMETRICSGROUP, INC.**

 

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**FOR THE THREE MONTHS ENDED MARCH 31,2008**

 

Options to purchase 1,094,355 and 1,341,138common shares during the three months ended March 31, 2007 and 2008,respectively, were anti-dilutive and were therefore excluded from thecomputation of diluted earnings per share.

 

**13. SEGMENT INFORMATION**

 

As of March 31, 2008, the Company hastwo reportable segments, the RiskMetrics business and the ISS business. Thesedesignations have been made as the discrete operating results of these segmentsare reviewed by the Company’s chief operating decision maker to assessperformance and make operating and asset allocation decisions. All intersegmenttransactions have been eliminated in the consolidated financial statements. TheCompany allocates corporate and other shared services to each segment based onthe employee’s geographic location and headcount. Goodwill and intangibleassets acquired in connection with the ISS and CFRA acquisitions are includedin the ISS business segment assets 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 policy creationto comprehensive research, vote recommendations, reliable vote execution,post-vote disclosure and reporting and analytical tools.

 

18

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**RISKMETRICSGROUP, INC.**

 

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**FOR THE THREE MONTHS ENDED MARCH 31,2008**

 

Results of operations by segment for the three months ended March 31,2007 is as follows:

 
| ** **                                               | ** ** | **RiskMetrics  Business** | ** ** | **ISS  Business** | ** ** | **Total** | ** ** |
|----------------------------------------------------------|------------|---------------------------|------------|-------------------|------------|-----------|------------|
| Three months ended March 31, 2007:                  |       |                      |       |              |       |      |       |
| Revenues                                                 |       | $                         | 27,319     |              | $          | 25,046    |       | $ | 52,365 |   |
| Depreciation and amortization of property  and equipment |       | 1,073                     |       | 511               |       | 1,584     |       |
| Amortization of intangible assets                        |       | —                    |       | 4,189             |       | 4,189     |       |
| Other operating expenses                                 |       | 20,297                    |       | 17,787            |       | 38,084    |       |
| Income from operations                                   |       | $                         | 5,949      |              | $          | 2,559     |       | $ | 8,508 |   |
| Interest, dividend and investment income                 |       |                      |       |              |       | 586       |       |
| Interest expense                                         |       |                      |       |              |       | (8,490    | )          |
| Income before income taxes                               |       |                      |       |              |       | 604       |       |
| Provision for income taxes                               |       |                      |       |              |       | 315       |       |
| Net income                                               |       |                      |       |              |       | $         | 289        |   |

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

 

**14. SUBSEQUENT EVENT**.

 

In May 2008, the Company entered into a contract for the sale ofits RiskManager and Hedge Platform products to Duff Capital Advisors. PhilipDuff, one of the Company’s directors, is the founder, CEO and General Partnerof Duff Capital Advisors. The contract was negotiated in the normal course ofbusiness on terms that are consistent with (and not preferential to) thoseprovided to other clients. The Company anticipates that the annual amount to bepaid to the Company by Duff Capital Advisors will be approximately$1 million.

 

19

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**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 91.6% of our total revenues in the three monthsended March 31, 2008, and we had a renewal rate of 88.4% 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 EDITDA 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.

 

20

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

 

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 renew automaticallyon an annual basis. Our products and services are generally priced based on theaccess to our applications and services, including research, voting and reportspurchased. We do not price our products and services based on our clients’assets under management. As a result, we are not subject to revenuefluctuations resulting from changes in our clients’ assets under management (“AUM”).Our experience has been that, over time, our clients have often added users andpurchased additional products and services from us, which has led to increasesin our revenues per client.

 

Revenues from subscription contracts arereferred to as recurring revenues. Recurring revenues are generated through therenewal of existing contracts and the signing of new subscription contracts.For the three months ended March 31, 2008, approximately 91.6% of ourtotal revenues were generated from these subscription contracts. Thesubscription fees received from our clients are recorded as deferred revenuesand recognized each month as our services are rendered. Our renewal rate, whichwas 88.4% for the three months ended March 31, 2008, combined with ourlevel of new subscription contracts, determine our annualized contract value,which is a leading indicator of our recurring revenues. Our annualized contractvalue as of March 31, 2008 was $267,564.

 

We also generate non-recurring revenue fromsales of products and services without a subscription contract, whichrepresented 8.4% of total revenues during the three months ended March 31,2008.

 

*Annualized Contract Value*

 

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 U.S. GAAP.

 

21

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Our annualized contract value for theRiskMetrics business and ISS business as of March 31, 2007, December 31,2007, and March 31, 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.

 

**Year-Over-Year Comparison**

 
| ** **                                      | ** ** | **As of March 31,** | ** ** |
|-------------------------------------------------|------------|------------------------------------|------------|
| ** **                                      | ** ** | **2007**                           | ** ** | **2008** | ** ** |
| RiskMetrics business annualized contract  value |       | $                                  | 109,295    |   | $ | 142,505 |   |
| Percent growth                                  | * *   | * *                           | * *   | *30.4* | *%* |
| ISS business annualized contract value          |       | $                                  | 94,360     |   | $ | 125,059 |   |
| Percent growth                                  | * *   |                               | * *   | *32.5* | *%* |

 

**Sequential Comparison**

 
| ** **                                                         | ** ** | **As of December 31, 2007** | ** ** | **As of March 31, 2008** | ** ** |
|--------------------------------------------------------------------|------------|-------------------------------------------------|------------|----------------------------------------------|------------|
| RiskMetrics business annualized contract value |       | $                                               | 131,716    |                                         | $          | 142,505 |   |
| Percent growth                                                     | * *   | * *                                        | * *   | *8.2*                                        | *%*        |
| ISS business annualized contract value                             |       | $                                               | 118,522    |                                         | $          | 125,059 |   |
| Percent growth                                                     | * *   | * *                                        | * *   | *5.5*                                        | *%*        |

 

*Renewal Rate*

 

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

 

The renewal rate for our RiskMetrics businessand ISS business for the three months ended March 31, 2007 and 2008, isset forth separately for each business, in the table below.

 
| ** **                        | ** ** | **Three Months Ended  March 31,** | ** ** |
|-----------------------------------|------------|--------------------------------------------------|------------|
| ** **                        | ** ** | **2007**                                         | ** ** | **2008** | ** ** |
| RiskMetrics business renewal rate |       | 87.6                                             | %          | 87.7 | % |
| ISS business renewal rate         |       | 89.0                                             | %          | 89.6 | % |

 

*Non-Recurring Revenues*

 

Non-recurring revenues result from sales on anon-subscription basis. Non-recurring revenues for the RiskMetrics business andISS business for the three months ended March 31, 2007 and 2008 are setforth in the table below. Our non-subscription services include implementation,compensation advisory services and similar services and overages related to ISS’Proxy Research and Voting business. Revenues from implementation are recognizedas the related subscription service is provided, some Compensation AdvisoryServices revenues are recognized over a three month period and othernon-recurring revenues are recognized once the service is provided. To theextent that clients’ actual usage of proxy voting services or proxy researchreports exceeds contracted-for limits, the excess usage is considered to be anoverage and clients are charged additional fees. Our clients’ overages aretypically an indication of larger proxy voting contract renewals.

 
| ** **                                          | ** ** | **Three Months Ended  March 31,** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                          | ** ** | **2007**                                         | ** ** | **2008** | ** ** |
| RiskMetrics business percent non-recurring  revenue |       | 2.9                                              | %          | 1.0 | % |
| ISS business percent non-recurring revenue          |       | 16.6                                             | %          | 15.4 | % |

 

22

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***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.

 

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. Costs in this area consist primarily ofstaff compensation and related costs and payments to third party vendors,including third party web hosting and data providers.

 

*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 intangibles which have been acquired.

 

*Amortization of Intangible Assets*

 

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

 

23

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***Adjusted EBITDA***

 

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

 
| ** **      | ** ** | **Three months ended  March 31,** | ** ** | ** ** | ** ** | ** **        | ** ** |
|-----------------|------------|--------------------------------------------------|------------|------------|------------|-------------------|------------|
| ** **      | ** ** | **2007**                                         | ** ** | **2008**   | ** ** | **$ Growth** | ** ** | **% Growth** | ** ** |
|            |       |                                             |       |       |       |              |       |   |   |
| Adjusted EBITDA |       | $                                                | 15,077     |       | $          | 23,203            |       | $ | 8,126 |   | 53.9 | % |
|                 |            |                                                  |            |            |            |                   |            |  |  |  |  |  |

 

Adjusted EBITDA for the three months ended March 31, 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 (affecting amortizationexpense) and compensation plans (affecting stock-based compensation expense).

 

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

 

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

 

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

 

·                                          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

 

24

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

 

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

 
| ** **                                               | ** ** | **Three months ended  March 31,** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                               | ** ** | **2007**                                         | ** ** | **2008** | ** ** |
| Net income                                               |       | $                                                | 289        |   | $ | 347 |   |
| Interest, other expense, net                             |       | 7,904                                            |       | 11,477 |   |
| Income tax expense                                       |       | 315                                              |       | 227 |   |
| Depreciation and amortization of property  and equipment |       | 1,584                                            |       | 2,115 |   |
| Amortization of intangible assets                        |       | 4,189                                            |       | 5,456 |   |
| Stock-based compensation.                                |       | 796                                              |       | 3,361 |   |
| Non-recurring expenses (a)                               |       | —                                           |       | 198 |   |
| Loss on disposal of property and equipment               | ** ** | **—**                                       |       | 22 |   |
| Adjusted EBITDA                                          |       | $                                                | 15,077     |   | $ | 23,203 |   |

 

----

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

 

**Critical Accounting Policies and Estimates**

 

Our condensedconsolidated financial statements are prepared in conformity with accountingprinciples generally accepted in the United States. Our critical accountingpolicies, including the assumptions and judgments underlying them, require theapplication of significant judgment in the preparation of our financialstatements, 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,accounting for income taxes and other matters that affect the condensedconsolidated financial statements and related disclosures.  There havebeen no changes to our significant accounting policies since December 31,2007.

 

**Results of Operations**

 

Based on a review of SFAS No. 131, *Disclosures about Segments of an Enterprise andRelated Information,* we have determined that we operate in twosegments, “the RiskMetrics business” and the “ISS business.” We have provided adiscussion of our results of operations on a consolidated basis and have alsoprovided certain detailed discussions 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 and is being integratedto support the Financial Research and Analysis product and services offerings.

 

InJanuary 2008, we completed our initial public offering in which we issued12.1 million shares and received net proceeds of $193.9 million. As such,weighted average common shares outstanding for the three months ended March 31,2008 includes these additional shares. In addition, immediately prior tothe completion of our initial public offering we granted each of our full-timeemployees an option to acquire 500 shares of our common stock, at an exerciseprice equal to the initial public offering price. Such grant resulted in stockbased compensation of $1,357 being recorded for the three months ended March 31,2008.

 

In January 2008, we utilized a portion of proceeds from theinitial public offering to prepay the entire outstanding indebtedness under thesecond lien loan, which amounted to $125.0 million. As a result of theprepayment we incurred $5.0 million in expenses, which consisted of a$1.25 million debt prepayment penalty fee, a $2.4 million debt issuancecost write 

 

25

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off and a $1.4 million loss on an interest rate swap settlement,during the three months ended March 31, 2008. Such costs have beenincluded in interest, dividend, investment and other income (expense), net inthe statements of income for the three months ended March 31, 2008.

 

*Risk Metrics Group, Inc.*

 

*Three months ended March 31, 2007compared to the three months ended March 31, 2008*

 
| ** **                                                      | ** ** | **Three months ended  March 31,**                   | ** ** | **Increase (decrease) for three  months ended March 31, 2008  compared to 2007** | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                      | ** ** | **2007**                                                           | ** ** | **2008**                                                                                                                      | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                                                      | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Revenues                                                        |       | $                                                                  | 52,365     |                                                                                                                          | $          | 71,220 |   | $ | 18,855 |   | 36.0 | % |
| Operating costs and expenses:                                   |       |                                                               |       |                                                                                                                          |       |   |   |   |   |
| Cost of revenues(1)                                             |       | 16,593                                                             |       | 22,704                                                                                                                        |       | 6,111 |   | 36.8 | % |
| Research and development expenses(1)                            |       | 6,879                                                              |       | 10,461                                                                                                                        |       | 3,582 |   | 52.1 | % |
| Selling and marketing expenses(1)                               |       | 8,093                                                              |       | 9,206                                                                                                                         |       | 1,113 |   | 13.8 | % |
| General and administrative expenses(1)                          |       | 6,519                                                              |       | 9,205                                                                                                                         |       | 2,686 |   | 41.2 | % |
| Depreciation and amortization of property  and equipment        |       | 1,584                                                              |       | 2,115                                                                                                                         |       | 531 |   | 33.5 | % |
| Amortization of intangible assets                               |       | 4,189                                                              |       | 5,456                                                                                                                         |       | 1,267 |   | 30.2 | % |
| Loss on disposal of fixed assets                                |       | —                                                             |       | 22                                                                                                                            |       | 22 |   | — |   |
| Total operating costs and expenses                              |       | 43,857                                                             |       | 59,169                                                                                                                        |       | 15,312 |   | 34.9 | % |
| Income from operations                                          |       | 8,508                                                              |       | 12,051                                                                                                                        |       | 3,543 |   | 41.6 | % |
| Interest, dividend, investment and other  income (expense), net |       | (7,904                                                             | )          | (11,477                                                                                                                       | )          | (3,573 | ) | 45.2 | % |
| Income before provision for income taxes                        |       | 604                                                                |       | 574                                                                                                                           |       | (30 | ) | (5.0 | )% |
| Provision for income taxes                                      |       | 315                                                                |       | 227                                                                                                                           |       | (88 | ) | (27.9 | )% |
| Net income                                                      |       | $                                                                  | 289        |                                                                                                                          | $          | 347 |   | $ | 58 |   | 20.1 | % |
|                                                            |       |                                                               |       |                                                                                                                          |       |   |   |   |   |
| EPS – Basic and Diluted                                    |       | $                                                                  | 0.01       |                                                                                                                          | $          | 0.01 |   |   |   |   |   |

 

----

(1)           Stock-basedcompensation expense included in operating expenses is as follows:

 
| ** **                             | ** ** | **Three months ended  March 31,**                   | ** ** | **Increase (decrease) for three  months ended March 31, 2008  compared to 2007** | ** ** |
|----------------------------------------|------------|--------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                             | ** ** | **2007**                                                           | ** ** | **2008**                                                                                                                      | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                             | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Cost of revenues                       |       | $                                                                  | 192        |                                                                                                                          | $          | 1,558 |   | $ | 1,366 |   | 711.5 | % |
| Research and development expenses      |       | 199                                                                |       | 781                                                                                                                           |       | 582 |   | 292.5 | % |
| Selling and marketing expenses         |       | 107                                                                |       | 321                                                                                                                           |       | 214 |   | 200.0 | % |
| General and administrative expenses    |       | 298                                                                |       | 701                                                                                                                           |       | 403 |   | 135.2 | % |
| Total stock-based compensation expense |       | $                                                                  | 796        |                                                                                                                          | $          | 3,361 |   | $ | 2,565 |   | 322.2 | % |

 

The following table provides information withrespect to our revenues in certain geographic regions:

 
| ** **                            | ** ** | **Three months ended**

**March 31, 2007**     | ** ** | **Three months ended  March 31, 2008** | ** ** | **Increase (decrease) for three  months ended March 31, 2008  compared to 2007** | ** ** |
|---------------------------------------|------------|--------------------------------------------------------------------|------------|------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------|------------|
| **Region**                            | ** ** | **Revenue**                                                        | ** ** | **% of  Total  Revenue**                              | ** ** | **Revenue**                                                                                                                   | ** ** | **% of  Total  Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                            | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Americas                              |       | $                                                                  | 32,914     |                                                       | 62.9       | %                                                                                                                             | $          | 44,630 |   | 62.7 | % | $ | 11,716 |   | 35.6 | % |
| Europe, Middle East and Africa (EMEA) |       | 16,190                                                             |       | 30.9                                                       | %          | 22,386                                                                                                                        |       | 31.4 | % | 6,196 |   | 38.3 | % |
| Asia                                  |       | 3,261                                                              |       | 6.2                                                        | %          | 4,204                                                                                                                         |       | 5.9 | % | 943 |   | 28.9 | % |
| Total                                 |       | $                                                                  | 52,365     |                                                       | 100.0      | %                                                                                                                             | $          | 71,220 |   | 100.0 | % | $ | 18,855 |   | 36.0 | % |

 

26

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Set forth below is a discussion of the threemonths ended March 31, 2007 compared to the three months ended March 31,2008 for RiskMetrics Group, Inc. For a more detailed discussion of theresults of operations of each of our RiskMetrics and ISS businesses, please seethe separate discussions of the results of operations for RiskMetrics and ISSfor these periods set forth below.

 

*Revenues.*  Revenues increased from $52.4 millionfor the three months ended March 31, 2007 to $71.2 million for the threemonths ended March 31, 2008, or 36.0%. Revenue growth was driven by a 26.1% increase in the RiskMetricsbusiness as a result of increased Market Risk revenue and EMEA revenuegrowth. In addition, ISS revenue increased 46.9% due to the acquisition ofCFRA which generated $4.4 million of revenue, the inclusion of 11 additionaldays in the three months ended March 31, 2008 and organic revenue growthin the governance services and financial research and analysis product lines.

 

*Operating costs and expenses.*  Totaloperating expenses increased from $43.9 million for the three months endedMarch 31, 2007 to $59.2 million for the three months ended March 31,2008, or 34.9%. The increase in operating expenses was due to the acquisitionof CFRA and increased compensation expense, including increased stock basedcompensation of $2.6 million. As a percentage of revenue, operating expensesdecreased from 83.8% to 83.1% due to increased economies of scale partiallyoffset by increased amortization and stock-based compensation expense.

 

*Cost of revenues.*  Cost of revenues increased from$16.6 million for the three months ended March 31, 2007 to $22.7million for the three months ended March 31, 2008, or 36.8%. As apercentage of revenues, cost of revenues increased slightly from 31.7% to31.9%. The increase in cost of revenues resulted primarily from increasedstock-based compensation of $1.4 million and increases at ISS as a result ofadditional CFRA costs which historically generate a higher cost of revenue,partially offset by increased margins in the RiskMetrics business.

 

*Research and development expenses.*  Research and development expenses increasedfrom $6.9 million for the three months ended March 31, 2007 to $10.5million for the three months ended March 31, 2008, or 52.1%. As apercentage of revenues, research and development expenses increased from 13.1%to 14.7% primarily due to increased stock-based compensation expense of $0.6million and increased investment in research and development related togovernance service products and platforms.

 

*Selling and marketing expenses.*  Selling and marketing expenses increased from$8.1 million for the three months ended March 31, 2007 to $9.2million for the three months ended March 31, 2008, or 13.8%. As apercentage of revenues, selling and marketing expenses decreased from 15.4% to12.9% due to the synergies achieved from the integration of the Company’sglobal sales force, product rebranding costs in the prior year and lower traveland entertainment expenses.

 

*General and administrative expenses.*  General and administrative expenses increasedfrom $6.5 million for the three months ended March 31, 2007 to $9.2million for the three months ended March 31, 2008, or 41.2%. As apercentage of revenues, general and administrative expenses increased from12.4% to 12.9% due to increased stock based compensation of $0.4 million andincreased compensation and professional fees as a result of regulatoryrequirements as a public company.

 

*Depreciation and amortization of property andequipment.* Depreciation and amortization of property and equipment increased from$1.6 million for the three months ended March 31, 2007 to $2.1 millionfor the three months ended March 31, 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 $4.2 million for the three months ended March 31, 2007 to $5.5million for the three months ended March 31, 2008 primarily from ouracquisition of CFRA on August 1, 2007 and purchase of a covenant not tocompete.

 

*Interest, dividend and investment income(expense), net.* Net interest, dividend and investment expense increased from$7.9 million for the three months ended March 31, 2007 to $11.5million for the three months ended March 31, 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, which amountedto $125.0 million. As a result of the prepayment we incurred $5.0 millionin expenses, which consisted of a $1.25 million debt prepayment penaltyfee, a $2.4 million debt issuance cost write off and a $1.4 million losson an interest rate swap settlement, during the three months ended March 31,2008. This increase in expense was partially offset by decreased interestexpense (net of amortization) and increased interest income as a result ofreduced debt borrowings and increased cash balances during 2008. We expect thistrend of lower interest expense and increased interest income to continue forthe remainder of fiscal 2008.

 

27

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*Provision for income taxes.*  The provision for income taxes represents aneffective tax rate of 39.5% for the three months ended March 31, 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 projected pre-tax income. Effectivetax rates are subject to change based on the taxable income in all thejurisdictions in which we do business.

 

*Net income.*  Net income was $0.3 million for thethree months ended March 31, 2007 and 2008. Earnings per share (diluted)for the three months ended March 31, 2007 and 2008 was $0.01. Net incomeand EPS for the three months ended March 31, 2008 was adversely impactedby $6.4 million in one-time IPO and debt pre-payment related pre-tax charges.

 

**Segment results of operations**

 

*RiskMetrics Business*

 

*Three months ended March 31, 2007compared to the three months ended March 31, 2008*

 
| ** **                                               | ** ** | **Three months ended  March 31,**                   | ** ** | **Increase (decrease) for three  months ended March 31,  2008 compared to 2007** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                               | ** ** | **2007**                                                           | ** ** | **2008**                                                                                                                      | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                                               | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Revenues                                                 |       | $                                                                  | 27,319     |                                                                                                                          | $          | 34,436 |   | $ | 7,117 |   | 26.1 | % |
| Operating costs and expenses:                            |       |                                                               |       |                                                                                                                          |       |   |   |   |   |
| Cost of revenues(1)                                      |       | 7,409                                                              |       | 8,133                                                                                                                         |       | 724 |   | 9.8 | % |
| Research and development expenses(1)                     |       | 5,656                                                              |       | 7,079                                                                                                                         |       | 1,423 |   | 25.2 | % |
| Selling and marketing expenses(1)                        |       | 4,027                                                              |       | 4,330                                                                                                                         |       | 303 |   | 7.5 | % |
| General and administrative expenses(1)                   |       | 3,205                                                              |       | 4,438                                                                                                                         |       | 1,233 |   | 38.5 | % |
| Depreciation and amortization of property  and equipment |       | 1,073                                                              |       | 1,160                                                                                                                         |       | 87 |   | 8.1 | % |
| Loss on disposal of fixed assets                         |       | ––                                                       |       | 9                                                                                                                             |       | 9 |   | –– |   |
| Total operating costs and expenses                       |       | 21,370                                                             |       | 25,149                                                                                                                        |       | 3,779 |   | 17.7 | % |
| Income from operations                                   |       | $                                                                  | 5,949      |                                                                                                                          | $          | 9,287 |   | 3,338 |   | 56.1 | % |
|                                                          |            |                                                                    |            |                                                                                                                               |            |  |  |  |  |  |  |  |

 

 

----

(1)                                  Stock-basedcompensation expense included in operating expenses is as follows:

 
| ** **                              | ** ** | **Three months ended  March 31,**                   | ** ** | **Increase (decrease) for three  months ended March 31,  2008 compared to 2007** | ** ** |
|-----------------------------------------|------------|--------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                              | ** ** | **2007**                                                           | ** ** | **2008**                                                                                                                      | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                              | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Cost of revenues                        |       | $                                                                  | 192        |                                                                                                                          | $          | 384 |   | $ | 192 |   | 100 | % |
| Research and development expenses       |       | 199                                                                |       | 375                                                                                                                           |       | 176 |   | 88.4 | % |
| Selling and marketing expenses          |       | 107                                                                |       | 190                                                                                                                           |       | 83 |   | 77.6 | % |
| General and administrative expenses     |       | 298                                                                |       | 389                                                                                                                           |       | 91 |   | 30.5 | % |
| Total stock-based compensation expenses |       | $                                                                  | 796        |                                                                                                                          | $          | 1,338 |   | $ | 542 |   | 68.1 | % |

 

The followingtable provides information with respect to our revenues in certain geographicregions:

 
| ** **                            | ** ** | **Three months ended  March 31, 2007**         | ** ** | **Three months ended  March 31, 2008** | ** ** | **Increase (decrease) for three  months ended March 31,  2008 compared to 2007** | ** ** |
|---------------------------------------|------------|--------------------------------------------------------------------|------------|------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------|------------|
| **Region**                            | ** ** | **Revenue**                                                        | ** ** | **% of  Total  Revenue**                              | ** ** | **Revenue**                                                                                                                   | ** ** | **% of  Total  Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                            | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Americas                              |       | $                                                                  | 12,758     |                                                       | 46.7       | %                                                                                                                             | $          | 15,534 |   | 45.1 | % | $ | 2,776 |   | 21.8 | % |
| Europe, Middle East and Africa (EMEA) |       | 12,399                                                             |       | 45.4                                                       | %          | 16,275                                                                                                                        |       | 47.3 | % | 3,876 |   | 31.3 | % |
| Asia                                  |       | 2,162                                                              |       | 7.9                                                        | %          | 2,627                                                                                                                         |       | 7.6 | % | 465 |   | 21.5 | % |
| Total                                 |       | $                                                                  | 27,319     |                                                       | 100.0      | %                                                                                                                             | $          | 34,436 |   | 100.0 | % | $ | 7,117 |   | 26.1 | % |

 

 

28

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*Revenues.* Revenues increased from $27.3 million for the three months ended March 31,2007 to $34.4 million for the three months ended March 31, 2008, or 26.1%.The $7.1 million increase in revenues was primarily due to a$7.9 million, or 38.9%, increase in revenues from our Market Risk productsand services partially offset by a decline in hedge-platform products. Theincrease in revenues from our Market Risk products and services was due tostrong sales of RiskManager to asset managers and hedge funds as they increasedtheir outsourcing of risk reporting services. Increased revenues resulted fromboth increased sales to existing customers and sales to new customers. As apercentage of total revenues, revenues from our Market Risk products andservices increased from 74.3% for the three months ended March 31, 2007 to81.8% for the three months ended March 31, 2008.

 

Revenue growthwas also driven by a 21.8% increase in the Americas region and a 31.3% increasein the EMEA region driven by strong sales of RiskManager in these regions dueto, among other things, the need for financial services firms to comply withnew regulatory requirements.

 

*Operating costs and expenses.*  Operating expenses increased from$21.4 million for the three months ended March 31, 2007 to$25.1 million for the three months ended March 31, 2008, or 17.7%.The increase was mainly due to increased compensation costs of$1.8 million related to higher headcount, bonus accrual and commissions,increased stock-based compensation expense of $0.5 million and increased dataand occupancy costs. As a percentage of revenues, operating expenses decreasedfrom 78.2% to 73.0% due to increased economies of scale.

 

*Cost of revenues.*  Cost of revenues increased from$7.4 million for the three months ended March 31, 2007 to $8.1 millionfor the three months ended March 31, 2008, or 9.8%. The increase wasprimarily due to increased compensation costs including stock-basedcompensation of $0.2 million and a $0.3 million increase in third- partydata costs due to the increased breadth of product offerings. As a percentageof revenues, cost of revenues decreased from 27.1% to 23.6%.

 

*Research and development expenses.*  Research and development expenses increasedfrom $5.7 million for the three months ended March 31, 2007 to $7.1million for the three months ended March 31, 2008, or 25.2%. The increasewas primarily due to increased employee compensation costs of $1.4 million dueto an increased focus in market risk product development and a $0.2 millionincrease in stock-based compensation expenses. As a percentage of revenues,research and development expenses decreased from 20.7% to 20.6%.

 

*Selling and marketing expenses.*  Selling and marketing expenses increased from$4.0 million for the three months ended March 31, 2007 to $4.3million for the three months ended March 31, 2008, or 7.5%. The increasewas primarily due to increased commissions as a result of the increase in salesoffset by the integration of the Company’s global sales force which reducedcosts, lower marketing expenses and decreased travel and entertainmentexpenses. As a percentage of revenues, selling and marketing expenses decreasedfrom 14.7% to 12.6%.

 

*General and administrative expenses.*  General and administrative expenses increasedfrom $3.2 million for the three months ended March 31, 2007 to $4.4million for the three months ended March 31, 2008, or 38.5%. The increasewas primarily due to increased employee compensation costs of $0.5 million dueto increased headcount as well as increased occupancy costs to support thegrowth in business and regulatory costs of being a public company. As apercentage of revenues, general and administrative expenses increased from11.7% to 12.9%.

 

*Depreciation and amortization of property and equipment.*  Depreciation and amortization of property andequipment increased from $1.1 million for the three months ended March 31,2007 to $1.2 million for the three months ended March 31, 2008, or 8.1%due to increased capital expenditures.

 

29

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*ISS Business*

 

*The period January 12, 2007 to March 31,2007 compared to the three months ended March 31, 2008*

 
| ** **                                               | ** ** | **January 12, 2007**                                     | ** ** | **Three months ended** | ** ** | **Increase (decrease) for the three  months ended March 31, 2008  compared to the period  January 12, 2007 to March 31, 2007** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                               | ** ** | **to March 31, 2007**                               | ** ** | **March 31, 2008**     | ** ** | **Amount**                                                                                                                                                                                                          | ** ** | **%** | ** ** |
| ** **                                               | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Revenues                                                 |       | $                                                                  | 25,046     |                             | $          | 36,784                                                                                                                                                                                                              |       | $ | 11,738 |   | 46.9 | % |
| Operating costs and expenses:                            |       |                                                               |       |                             |       |                                                                                                                                                                                                                |       |   |   |
| Cost of revenues(1)                                      |       | 9,185                                                              |       | 14,571                           |       | 5,386                                                                                                                                                                                                               |       | 58.6 | % |
| Research and development expenses(1)                     |       | 1,222                                                              |       | 3,382                            |       | 2,160                                                                                                                                                                                                               |       | 176.8 | % |
| Selling and marketing expenses(1)                        |       | 4,065                                                              |       | 4,876                            |       | 811                                                                                                                                                                                                                 |       | 20.0 | % |
| General and administrative expenses(1)                   |       | 3,315                                                              |       | 4,767                            |       | 1,452                                                                                                                                                                                                               |       | 43.8 | % |
| Depreciation and amortization of property  and equipment |       | 511                                                                |       | 955                              |       | 444                                                                                                                                                                                                                 |       | 86.9 | % |
| Amortization of intangible assets                        |       | 4,189                                                              |       | 5,456                            |       | 1,267                                                                                                                                                                                                               |       | 30.2 | % |
| Loss on disposal of fixed assets                         |       | ––                                                       |       | 13                               |       | 13                                                                                                                                                                                                                  |       | –– |   |
| Total operating costs and expenses                       |       | 22,487                                                             |       | 34,020                           |       | 11,533                                                                                                                                                                                                              |       | 51.3 | % |
| Income from operations                                   |       | $                                                                  | 2,559      |                             | $          | 2,764                                                                                                                                                                                                               |       | $ | 205 |   | 8.0 | % |

 

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(1)           Stock-based compensation expenseincluded in operating expenses is as follows:

 
| ** **                             | ** ** | **January 12, 2007**                                     | ** ** | **Three months ended** | ** ** | **Increase (decrease) for the three  months ended March 31, 2008  compared to the period  January 12, 2007 to March 31, 2007** | ** ** |
|----------------------------------------|------------|--------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                             | ** ** | **to March 31, 2007**                               | ** ** | **March 31, 2008**     | ** ** | **Amount**                                                                                                                                                                                                          | ** ** | **%** | ** ** |
| ** **                             | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Cost of revenues                       |       | $                                                                  | —     |                             | $          | 1,174                                                                                                                                                                                                               |       | $ | 1,174 |   | — |   |
| Research and development expenses      |       | —                                                             |       | 407                              |       | 407                                                                                                                                                                                                                 |       | — |   |
| Selling and marketing expenses         |       | —                                                             |       | 130                              |       | 130                                                                                                                                                                                                                 |       | — |   |
| General and administrative expenses    |       | —                                                             |       | 312                              |       | 312                                                                                                                                                                                                                 |       | — |   |
| Total stock-based compensation expense |       | $                                                                  | —     |                             | $          | 2,023                                                                                                                                                                                                               |       | $ | 2,023 |   | — |   |

 

The followingtable provides information with respect to our ISS business revenues in certaingeographic regions:

 
| ** **                            | ** ** | **January 12, 2007  to March 31, 2007** | ** ** | **Three months ended  March 31, 2008** | ** ** | **Increase (decrease) for the three  months ended March 31, 2008  compared to the period January   12, 2007 to March 31, 2007** | ** ** |
|---------------------------------------|------------|------------------------------------------------------------------|------------|------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                            | ** ** | ** **                                                       | ** ** | **% of Total**                                   | ** ** | ** **                                                                                                                                                                                                                | ** ** | **% of Total** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Region**                            | ** ** | **Revenue**                                                      | ** ** | **Revenue**                                                | ** ** | **Revenue**                                                                                                                                                                                                               | ** ** | **Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                            | ** ** | **(Amounts  in thousands, except percentages)**                  | ** ** |
| Americas                              |       | $                                                                | 20,155     |                                                       | 80.5       | %                                                                                                                                                                                                                         | $          | 29,097 |   | 79.1 | % | $ | 8,942 |   | 44.4 | % |
| Europe, Middle East and Africa (EMEA) |       | 3,791                                                            |       | 15.1                                                       | %          | 6,110                                                                                                                                                                                                                     |       | 16.6 | % | 2,319 |   | 61.2 | % |
| Asia                                  |       | 1,100                                                            |       | 4.4                                                        | %          | 1,577                                                                                                                                                                                                                     |       | 4.3 | % | 477 |   | 43.4 | % |
| Total                                 |       | $                                                                | 25,046     |                                                       | 100.0      | %                                                                                                                                                                                                                         | $          | 36,784 |   | 100.0 | % | $ | 11,738 |   | 46.9 | % |

 

*Revenues.* Revenues increased from $25.0 million for the period from January 12,2007 to March 31, 2007 to $36.8 million for the three months ended March 31,2008, or 46.9%. Revenue for the three months ended March 31, 2008 waspositively impacted by additional revenues of $4.4 million from CFRA,which was acquired on August 1, 2007.

 

During theperiod from January 1 to January 11, 2007, ISS recognized revenues of$3.3 million. Had this revenue been included in the three months ended March 31,2007, revenue would have been $28.4 million, an increase of 29.6% ascompared to the three months ended March 31, 2007. All the informationprovided in the remainder of this paragraph reflects the inclusion of therevenues for this 11-day period. The increase in revenues was primarily due toan increase in revenue 

 

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from our Financial Research andAnalysis products and services which increased from $8.3 million to$14.4 million, or 74.2%, due to the inclusion of $4.4 million of CFRArevenue and the growth of our revenues from our Corporate and CompensationAdvisory Services, ES&G and M&A Edge products. Revenues from ourGovernance Services products increased 11.4% from $20.1 million to$22.4 million due to increased revenue in all proxy research and votingservices. Governance services revenue accounted for 60.9% of total revenue forthe three months ended March 31, 2008 compared to 70.9% in the prior year.Revenues from the Americas accounted for 79.1% of ISS revenues in the threemonths ended March 31, 2008, down from 80.5% in the three months ended March 31,2007, as ISS continued to diversify geographically.

 

*Operating costs and expenses.*  Total operating expenses increased from$22.5 million for the period from January 12, 2007 to March 31,2007 to $34.0 million for the three months ended March 31, 2008, or 51.3%.The increase in operating expenses was primarily due to increased compensationof $5.3 million (including CFRA), additional operating expenses from CFRA,increased amortization expense of $1.3 million, a $2.0 million increase instock-based compensation expense, and the inclusion of 11 additional days in the2008 period. As a percentage of revenues, operating costs and expensesincreased from 89.8% to 92.5% primarily due to an increase in stock basedcompensation and amortization expense.

 

*Cost of revenues.*  Cost of revenues increased from$9.2 million for the period from January 12, 2007 to March 31,2007 to $14.6 million for the three months ended March 31, 2008, or 58.6%.The increase was primarily due to additional CFRA costs, compensation costs,including stock-based compensation of $1.2 million and occupancy costs. Asa percentage of revenues, cost of revenues increased from 36.7% to 39.6%,primarily due to increased stock-based and CFRA revenue in the current period,which historically generates a higher cost of revenue than ISS.

 

*Research and development expenses.*  Research and development expenses increasedfrom $1.2 million for the period from January 12, 2007 to March 31,2007 to $3.4 million for the three months ended March 31, 2008, or 176.8%.The increase was primarily due to increased compensation costs, includingstock-based compensation of $0.4 million, additional CFRA costs andinvestment in research and development related to governance service productsand platforms. As a percentage of revenues, research and development expensesincreased from 4.9% to 9.2%.

 

*Selling and marketing expenses.*  Selling and marketing expenses increased from$4.1 million for the period from January 12, 2007 to March 31,2007 to $4.9 million for the three months ended March 31, 2008, or 20.0%.The increase was primarily due to the inclusion of CFRA costs in 2008 andincreased compensation, including stock-based compensation expense. As apercentage of revenues, selling and marketing expenses decreased from 16.2% to13.3% due to the integration of the Company’s global sales force.

 

*General and administrative expenses.*  General and administrative expenses increasedfrom $3.3 million for the period from January 12, 2007 to March 31,2007 to $4.8 million for the three months ended March 31, 2008, or 43.8%.The increase was primarily due to increased stock-based compensation expense of$0.3 million, additional CFRA costs and increased professional fees due toincreased accounting and consulting fees. As a percentage of revenues, generaland administrative expenses decreased from 13.2% to 13.0%.

 

*Depreciation and amortization of property and equipment.*  Depreciation and amortization of property andequipment increased from $0.5 million for the period from January 12, 2007to March 31, 2007 to $1.0 million for the three months ended March 31,2008 due to increased capital expenditures for leasehold improvements.

 

*Amortization of intangible assets.*  Amortization of intangible assets increasedfrom $4.2 million for the period from January 12, 2007 to March 31,2007 to $5.5 million for the three months ended March 31, 2008, primarilydue to the purchase of a covenant not to compete agreement and intangibleassets acquired from CFRA.

 

**Liquidity and Capital Resources**

 

At March 31,2008 and December 31, 2007, we had cash and cash equivalents of $87.3million and $27.5 million, respectively. In January 2008, wecompleted our initial public offering of 14,000,000 shares of our common stock,which included 4,035,816 shares sold by our selling stockholders. We did notreceive any proceeds from the sale of the shares by the selling stockholders.In addition, we granted the underwriters an option to purchase a maximum of2,100,000 additional shares of common stock from us to cover over-allotments,which was exercised in full in January 2008. Our 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 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 

 

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future working capitalrequirements will depend on many factors, including our revenue growth, debtservice, future acquisitions of businesses and investments in our own business.To the extent, our liquidity sources are insufficient to fund our futureactivities we may need to raise additional funding through a public or privateequity or debt offering. No assurances can be given that additional financingwill be available in the future or that if available, such financing will be onfavorable terms.

 

*Cash Flows*

 

Our cash flowtends to be lower in the beginning of each year due to bonuses and commissionspaid during this period and due to the seasonality of contract renewals andcorresponding up-front payments, which are somewhat weighted in the second halfof each year. As a result of contract renewals being weighted during the secondhalf of the year and bonus payments in the beginning of the year, we generatemore cash flows from operations during the second half of the year than thefirst half of the year.

 

Operatingactivities for the three months ended March 31, 2008 used cash of$12.9 million primarily reflecting net income of $0.3 million plusdepreciation and amortization of $7.6 million, plus stock-based compensation of$3.4 million offset by a $13.4 million decline in accrued expenses due to bonuspayments and a $8.5 million net increase in accounts receivable and deferredrevenue.  Operating activities for the three months ended March 31,2007 used cash of $8.1 million primarily reflecting net income of $0.3 millionplus depreciation and amortization of $5.8 million, plus stock-basedcompensation of $0.8 million and a $2.7 million net increase in accountsreceivable and deferred revenue offset by a $16.6 million decline in accruedexpenses due to bonus payments.  Cash flow from operations decreased $4.9million in 2008 compared to 2007 due to $1.3 million of cash used for a debtpre-payment penalty fee and $1.4 million for a interest rate swap settlement inconnection with the pre-payment of debt in 2008 as well as the timing ofaccounts receivable billing and collections due to seasonality and integrationof the Company’s sale force.  The Company expects accounts receivablecollections in the second quarter and remainder of fiscal 2008 to generatepositive operating cash flow and exceed prior year.

 

Investingactivities for the three months ended March 31, 2008 used cash of $1.8million, primarily due to capital expenditures. Investing activities for thethree months ended March 31, 2007 used cash of $421.7 million, primarilydue to the acquisition of ISS, which included the net liquidation ofinvestments that provided us $59.5 million of cash, as well as capitalexpenditures of $2.1 million.

 

Financingactivities for the three months ended March 31, 2008 provided cash of$74.7 million as a result of $196.3 million raised from our initial publicoffering offset by the $125.0 million pre-payment on the second lien term loan.Financing activities for the three months ended March 31, 2007 providedcash of $415.0 million as a result of proceeds received from theincurrence of $425.0 million of indebtedness in connection with the ISSacquisition, partially offset by $10.1 million in debt issuance costs.

 

*Long Term Debt*

 

In connectionwith the purchase of ISS on January 11, 2007, we incurred$425.0 million of indebtedness. The indebtedness was comprised of firstlien and second lien term loans. We also entered into a first lien revolvingcredit facility. The terms of the indebtedness include various covenantcompliance requirements, including maintaining certain Adjusted EBITDA earninglevels, as defined in our credit facilities. The Company has pledged all of itsassets as collateral against the debt. Amounts paid under the term loans maynot be re-borrowed. The maturity dates of the first lien loan, second lien loanand revolving credit facility loans are January 2013, January 2014and July 2014, respectively.

 

In February 2007,we entered into two interest-rate swap agreements to reduce interest rate risksand to manage interest expense. By entering into these agreements, we changethe fixed/variable interest-rate mix of our debt portfolio. As of March 31,2008, the interest rate swaps had notional amounts of $281,063 and a fair valueliability of $18,952. The agreements effectively convert our floating-rate debtinto fixed-rate debt. This reduces our risk of incurring higher interest costsin periods of rising interest rates and increases our risk of paying higherinterest costs in periods of decreasing interest rates. Our interest-rate swapagreements hedge a significant portion of the interest rate risk exposure underour indebtedness. The interest rate swap agreements increased our weightedaverage effective interest rate on the first lien term loan facility to 7.35%and on the second lien term loan facility to 10.60% during the three monthsended March 31, 2008. The variable benchmark interest rates on Eurodollarbased loans associated with these instruments was 4.83% during the three monthsended March 31, 2008.

 

In January 2008,we utilized a portion of proceeds from our initial public offering to prepaythe entire outstanding indebtedness under our second lien loan which amountedto $125.0 million. In addition, we paid a 1% prepayment penalty 

 

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fee, or $1.25 million,upon prepayment as set forth in the credit agreement. In conjunction with therepayment of our second loan lien, we wrote off debt issuance costs of$2.4 million and reduced the notional amount of our interest rate swap by$19.3 million which resulted in additional expense of $1.4 millionduring the three months ended March 31, 2008. In April 2008, we paidan excess cash flow principal payment of $6.4 million for our first lien termloan, as required by the credit facility. The next principal debt payment of$750 is due on June 30, 2008.

 

As of March 31,2008, we were in compliance with our credit agreements, and we are not aware ofany future events or transactions that will impact such compliance.

 

*Commitments*

 

In addition tothe indebtedness discussed above, we enter into routine operating leaseobligations for our facilities and purchase obligations to operate ourbusiness. Our contractual commitments, including those related to ourindebtedness, were comprised of the following as of March 31, 2008:

 
| ** **                            | ** ** | **Payments Due by Period** | ** ** |
|---------------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligation**       | ** ** | **Total**                                 | ** ** | **Within 1 year** | ** ** | **1-3 years** | ** ** | **4-5 years** | ** ** | **After 5 years** | ** ** |
| Debt, including estimated interest    |       | $                                         | 421,937    |   | $ | 29,631 |   | $ | 51,779 |   | $ | 50,819 |   | $ | 289,708 |   |
| Operating leases                      |       | 27,043                                    |       | 6,210 |   | 12,201 |   | 8,044 |   | 588 |   |
| Purchase obligation for data          |       | 8,677                                     |       | 5,886 |   | 2,791 |   | –– |   | –– |   |
| Deferred purchase price obligation(1) |       | 1,365                                     |       | 201 |   | 432 |   | 476 |   | 256 |   |
| Total                                 |       | $                                         | 459,022    |   | $ | 41,928 |   | $ | 67,203 |   | $ | 59,339 |   | $ | 290,552 |   |

 

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(1)                                  Obligationrelates to prior acquisitions made by ISS.

 

*Off-Balance Sheet Arrangements*

 

We do notmaintain any off-balance sheet arrangements, transactions, obligations or otherrelationships with unconsolidated entities that would be expected to have amaterial current or future impact upon our financial condition or results ofoperations.

 

*Impact of Inflation*

 

Our businessmay be significantly or adversely affected by inflation. Due to the high degreeof competition in the marketplace, inflation rate increases might lead to anerosion of our profit margins.

 

*RelatedParty Transaction*

 

In May 2008,we entered into a contract for the sale of our RiskManager and Hedge Platformproducts to Duff Capital Advisors. Philip Duff, one of our directors, is thefounder, CEO and General Partner of Duff Capital Advisors. The contract wasentered into in the normal course of business on terms that are consistent with(and not preferential to) those provided to our other clients. We anticipatethat the annual amount to be paid to us by Duff Capital Advisors will beapproximately $1 million.

 

**Effects of Recently Issued AccountingPronouncements**

 

In September 2006,the FASB issued SFAS No. 157*, FairValue Measurements*, or SFAS 157. SFAS 157 defines fairvalue, establishes a framework for measuring fair value, and expandsdisclosures about fair value measurements. We adopted SFAS 157 on January 1,2008 and such adoption did not have a material impact on our condensedfinancial statements.

 

In February 2007,the FASB issued SFAS No. 159, *The FairValue Option for Financial Assets and Financial Liabilities*, orSFAS 159, providing companies with an option to report selected financialassets and liabilities at fair value. SFAS 159’s objective is to reduceboth complexity in accounting for financial instruments and the volatility inearnings caused by measuring related assets and liabilities differently.Accounting principles generally accepted within the United States have requireddifferent measurement attributes for different assets and liabilities that cancreate artificial volatility in 

 

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earnings. SFAS 159 helpsto mitigate this type of accounting-induced volatility by enabling companies toreport related assets and liabilities at fair value, which would likely reducethe need for companies to comply with detailed rules for hedge accounting.SFAS 159 also establishes presentation and disclosure requirementsdesigned to facilitate comparisons between companies that choose differentmeasurement 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. We adopted SFAS 159 on January 1, 2008 and suchadoption did not have an impact on our consolidated financial statements.

 

On December 4,2007, FASB issued Statement 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 isprohibited. Application of SFAS 141(R) and SFAS 160 is requiredto be adopted prospectively, except for certain provisions of SFAS 160,which are required to be adopted retrospectively. Business combinationtransactions accounted for before adoption of SFAS 141(R) should beaccounted for in accordance with Statement No. 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 adoption ofSFAS 141 (R) and SFAS 160 is not expected to have a materialimpact on our financial position or results of operations.

 

In March 2008, the FASBissued SFAS No. 161, “*Disclosures aboutDerivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133*”(“SFAS No. 161”). SFAS No. 161 establishes, among other things, thedisclosure requirements for derivative instruments and for hedging activities.SFAS No. 161 is effective for fiscal years and interim periods beginningafter November 15, 2008. We are currently assessing the impact that SFAS No. 161will have on our condensed consolidated financial statements.

 

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

 

Our primarymarket risk exposure is interest rate risk associated with short and long-termdebt bearing variable interest rates. To manage this interest rate riskexposure, we enter into interest rate swap agreements. We are also exposed toforeign currency risk, which can adversely affect our sales and operatingprofits. The following discussion should be read in conjunction withNote 8 of our consolidated financial statements appearing elsewhere inthis Form 10-Q, which provides further information on our derivativeinstruments.

 

*Interest Rate Sensitivity*

 

To reduce theexposure associated with our variable rate debt, we entered into twointerest-rate swap agreements to reduce interest rate risks and to manageinterest expense. By entering into these agreements, we change thefixed/variable interest-rate mix of our debt portfolio. As of March 31,2008, the interest rate swaps had notional amounts of $281,063 and a fair valueliability of $18,952. The agreements effectively convert our floating-rate debtinto fixed-rate debt. This reduces our risk of incurring higher interest costsin periods of rising interest rates. Our interest-rate swap agreements hedge asubstantial majority of the interest rate risk exposure under our indebtedness.The variable benchmark interest rates on eurodollar based loans associated withthese instruments ranged from 7.35% to 10.60%. Hypothetical, instantaneousincrease of one percentage point in the interest rates applicable to thevariable interest rate debt would have increased our net interest expense forthe three months ended March 31, 2008 by approximately $586.

 

*Exchange Rate Sensitivity*

 

We have twoseparate exposures to currency fluctuation risk—subsidiaries outside the UnitedStates which use a foreign currency as their functional currency which aretranslated into U.S. dollars for consolidation of assets and liabilities andnon-U.S. dollar invoiced revenues. Changes in foreign exchange rates for oursubsidiaries that use a foreign currency as their functional currency aretranslated into U.S. dollars and result in cumulative translation adjustments,which are included in accumulated other comprehensive loss. At March 31,2008, we had translation exposure to various foreign countries including theEuro, Pounds Sterling, Canadian Dollar, and a limited number of other non-U.S.dollars currencies. The 

 

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potential loss resulting from ahypothetical 10% adverse change in quoted foreign currency exchange rates, asof March 31, 2008, amounts to $1,450.

 

We invoice ourclients in U.S. dollars, however, we also invoice clients in Euro, CanadianDollar, Japanese Yen and a limited number of other non-U.S. dollar currencies.As such, the fluctuations in such currencies could impact our operatingresults. Our primary market risk exposure is interest rate risk associated withshort and long-term debt bearing variable interest rates. To manage thisinterest rate risk exposure, we enter into interest rate swap agreements. Weare also exposed to foreign currency risk, which can adversely affect our salesand operating profits.

 

**Item 4. Controls and Procedures**

 

**(a)****           Evaluation of Disclosure Controls andProcedures**

 

We carried outan evaluation, under the supervision and with the participation of ourmanagement, including our chief executive officer and chief financial officer, ofthe design and operation of our disclosure controls and procedures (as suchterm is defined in Rules 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934 (the “Exchange Act”) as of March 31, 2008,pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, thechief executive officer and chief financial officer concluded that the ourdisclosure controls and procedures as of March 31, 2008 are effective forgathering, analyzing and disclosing the information the Company is required todisclose in the reports it files under the Exchange Act, within the timeperiods specified in the Securities and Exchange Commission’s rules andforms.

 

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

 

There were nochanges in our internal controls over financial reporting during our fiscalquarter ended March 31, 2008 that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.

 

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** **

**Part II**

 

**Item 1. Legal Proceedings**

 

We are notpresently involved in any legal proceedings which we believe would have amaterial adverse effect on our consolidated financial statements. However,during the ordinary course of business, we are, from time to time, threatenedwith, or may become a party to, legal actions and other proceedings.

 

**Item 1A. Risk Factors**

 

There have been no material changes to therisk factors previously disclosed in Item 1A “Risk Factors” of the Annual  Report on Form 10-K.

 

**Item 2. Unregistered Sales of Equity Securities and Use of Proceeds**

 

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

 

On January 25,2008, we granted 1,563,500 options to our employees immediately prior to theconsummation of our initial public offering, including an aggregate of1,031,500 options related to 2007 compensation for certain employees and anaggregate of 532,000 options to all full time employees, representing aone-time grant of 500 options to each of our employees.

 

On January 30,2008, we completed our initial public offering of 16,100,000 shares of ourcommon stock, which included 4,035,816 shares sold by our selling stockholderpursuant to our Registration 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 portion of proceeds from the initial public offering to prepaythe entire outstanding indebtedness under the second loan lien credit facilitywhich amounted to $125.0 million and a 1% prepayment penalty fee, or$1.25 million. The remainder of proceeds from the initial public offeringwill be utilized for general corporate purposes, including working capital.

 

**Item 3.  Defaults Upon Senior Securities**

 

None.

 

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

 

None.

 

**Item 5. Other Information**

 

None.

 

**Item 6.  Exhibits**

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

 

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*                                         Filedherewith.

 

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** **

**SIGNATURES**

 

Pursuant tothe requirements of Section 13 or 15(d) of the Securities Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned; thereunto duly authorized this 15th day of May,2008.

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

 

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