Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

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

 

**For thequarterly period ended September 30, 2008**

 

**Commissionfile number: 001-33928**

 

**RiskMetrics Group, Inc.**

(Exact name of registrant asspecified in its charter)

 

| **Delaware**                    | ** ** | **20-8175809**      |
|---------------------------------|------------|---------------------|
| (State or other jurisdiction of |       | (IRS Employer       |
| incorporation or organization)  |       | Identification No.) |

 

| **One Chase Manhattan Plaza, 44****th Floor** | ** ** | ** ** |
|----------------------------------------------------|------------|------------|
| **New York, New York**                             | ** ** | **10005**  |
| (Address of principal executive offices)           |       | (Zip Code) |

 

**(212) 981-7475**

(Registrant’s telephonenumber, including area code)

 

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

 

Indicate by check mark whether the registrant 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 November 3rd, 2008 was:

 

| **Class**                   | ** ** | **Outstanding** |
|-----------------------------|------------|-----------------|
| Common stock $.01 par value |       | 61,382,497      |

 

 

 

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Table of Contents

 

**RiskMetricsGroup**

**Indexto Form 10-Q**

 

**Tableof Contents**

 
| ** **                                                                                                                                                                                   | ** **                                                                | **Page Number** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------|----------------------|
| **PART I – FINANCIAL INFORMATION**                                                                                                                                                 |                                                                      |                 |
| Item 1 — Financial Statements                                                                                                                                                      | ** **                                                                | ** **           |
| Condensed Consolidated Financial Statements  as of December 31, 2007 and September 30, 2008 and for the three  and nine months ended September 30, 2007 and 2008 (unaudited): |                                                                      |                 |
|                                                                                                                                                                                         | Condensed Consolidated Balance Sheets                                     |                 | 3 |
|                                                                                                                                                                                         | Condensed Consolidated Statements of Income                               |                 | 4 |
|                                                                                                                                                                                         | Condensed Consolidated Statements of Changes in Stockholders’ Equity |                 | 5 |
|                                                                                                                                                                                         | Condensed Consolidated Statements of Cash Flows                           |                 | 6 |
|                                                                                                                                                                                         | Notes to Condensed Consolidated Financial Statements                      |                 | 7 |
| Item 2 — Management’s Discussion and  Analysis of Financial Condition and Results of Operations                                                                               |                                                                      | 21                   |
| Item 3 —  Quantitative and Qualitative Disclosures About Market Risk                                                                                                               |                                                                      | 39                   |
| Item 4 -  Controls and Procedures                                                                                                                                                            |                                                                      | 40                   |
|                                                                                                                                                                                         |                                                                      |                 |
| **PART II – OTHER INFORMATION**                                                                                                                                                    | ** **                                                                | ** **           |
| Item 1 – Legal Proceedings                                                                                                                                                              |                                                                      | 40                   |
| Item 1A - Risk Factors                                                                                                                                                                  |                                                                      | 40                   |
| Item 2 –  Unregistered Sales of Equity Securities and Use of Proceeds                                                                                                                   |                                                                      | 41                   |
| Item 3 –  Defaults Upon Senior Securities                                                                                                                                          |                                                                      | 41                   |
| Item 4 —  Submission of Matters to a Vote of Security Holders                                                                                                                      |                                                                      | 41                   |
| Item 5 – Other Information                                                                                                                                                         |                                                                      | 41                   |
| Item 6 — Exhibits                                                                                                                                                                  |                                                                      | 41                   |

 

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**RISKMETRICSGROUP, INC.**

 

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(UNAUDITED)**

**(Inthousands, except share amounts)**

 
| ** **                                                                                                                                                                                                                                                                                      | ** ** | **December 31,   2007** | ** ** | **September 30,   2008** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|------------------------------------|------------|
| **ASSETS**                                                                                                                                                                                                                                                                                      | ** ** | ** **                        | ** ** | ** **                         | ** ** |
| CURRENT ASSETS:                                                                                                                                                                                                                                                                                 |       |                              |       |                               |       |
| Cash and cash equivalents                                                                                                                                                                                                                                                                       |       | $                                 | 27,455     |                               | $          | 151,661 |   |
| Accounts receivable, net                                                                                                                                                                                                                                                                        |       | 37,010                            |       | 48,028                             |       |
| Deferred tax asset                                                                                                                                                                                                                                                                              |       | 140                               |       | 128                                |       |
| Income taxes receivable                                                                                                                                                                                                                                                                         |       | 8,300                             |       | 2,397                              |       |
| Other receivables and prepaid expenses                                                                                                                                                                                                                                                          |       | 5,910                             |       | 5,953                              |       |
| Total current assets                                                                                                                                                                                                                                                                            |       | 78,815                            |       | 208,167                            |       |
| Intangibles—net                                                                                                                                                                                                                                                                            |       | 174,154                           |       | 157,844                            |       |
| Goodwill                                                                                                                                                                                                                                                                                        |       | 460,951                           |       | 461,218                            |       |
| Property and equipment—net                                                                                                                                                                                                                                                                 |       | 16,225                            |       | 15,103                             |       |
| Deferred financing costs                                                                                                                                                                                                                                                                        |       | 8,677                             |       | 5,487                              |       |
| Other assets                                                                                                                                                                                                                                                                                    |       | 4,361                             |       | 1,814                              |       |
| TOTAL ASSETS                                                                                                                                                                                                                                                                                    |       | $                                 | 743,183    |                               | $          | 849,633 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                                                   |       |                              |       |                               |       |
| CURRENT LIABILITIES:                                                                                                                                                                                                                                                                            |       |                              |       |                               |       |
| Trade accounts payable                                                                                                                                                                                                                                                                          |       | $                                 | 6,235      |                               | $          | 3,070 |   |
| Accrued expenses                                                                                                                                                                                                                                                                                |       | 34,189                            |       | 38,233                             |       |
| Debt, current portion                                                                                                                                                                                                                                                                           |       | 3,000                             |       | 1,483                              |       |
| Deferred revenue, current portion                                                                                                                                                                                                                                                               |       | 100,557                           |       | 114,181                            |       |
| Other current liabilities                                                                                                                                                                                                                                                                       |       | 227                               |       | 237                                |       |
| Total current liabilities                                                                                                                                                                                                                                                                       |       | 144,208                           |       | 157,204                            |       |
| LONG-TERM LIABILITIES                                                                                                                                                                                                                                                                           |       |                              |       |                               |       |
| Debt                                                                                                                                                                                                                                                                                            |       | 419,750                           |       | 289,137                            |       |
| Deferred tax liabilities                                                                                                                                                                                                                                                                        |       | 28,626                            |       | 29,129                             |       |
| Deferred revenue                                                                                                                                                                                                                                                                                |       | 722                               |       | 462                                |       |
| Other long-term liabilities                                                                                                                                                                                                                                                                     |       | 13,785                            |       | 14,088                             |       |
| Total liabilities                                                                                                                                                                                                                                                                               |       | $                                 | 607,091    |                               | $          | 490,020 |   |
|                                                                                                                                                                                                                                                                                            |       |                              |       |                               |       |
| COMMITMENTS AND CONTINGENCIES                                                                                                                                                                                                                                                                   |       |                              |       |                               |       |
|                                                                                                                                                                                                                                                                                            |       |                              |       |                               |       |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                                                                                                                                      |       |                              |       |                               |       |
| Common stock, $.01 par value—150,000,000  and 200,000,000 authorized at December 31, 2007 and September 30,  2008, respectively; 47,850,652 and 61,502,885 issued and 47,642,460 and  61,259,731outstanding at December 31, 2007 and September 30, 2008,  respectively |       | $                                 | 479        |                               | $          | 615 |   |
| Treasury stock—208,192 and 243,154 shares  at December 31, 2007 and September 30, 2008, respectively                                                                                                                                                                             |       | (2                                | )          | (579                               | )          |
| Additional paid-in capital                                                                                                                                                                                                                                                                      |       | 217,355                           |       | 429,485                            |       |
| Accumulated other comprehensive loss                                                                                                                                                                                                                                                            |       | (7,262                            | )          | (7,605                             | )          |
| Accumulated deficit                                                                                                                                                                                                                                                                             |       | (74,478                           | )          | (62,303                            | )          |
| Total stockholders’ equity                                                                                                                                                                                                                                                                 |       | 136,092                           |       | 359,613                            |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                                                                                                                 |       | $                                 | 743,183    |                               | $          | 849,633 |   |

 

See notes tocondensed consolidated financial statements.

 

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**RISKMETRICSGROUP, INC.**

 

**CONDENSED CONSOLIDATED STATEMENTS OF INCOME**

**FORTHE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2008**

 

**(UNAUDITED)**

 

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

 
| ** **                                                             | ** ** | **Three months ended   September 30,** | ** ** | **Nine months ended   September 30,** | ** ** |
|------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                             | ** ** | **2007**                                                   | ** ** | **2008**                                                  | ** ** | **2007** | ** ** | **2008** | ** ** |
| REVENUES                                                               |       | $                                                          | 62,159     |                                                      | $          | 75,554 |   | $ | 172,674 |   | $ | 220,900 |   |
| OPERATING COSTS AND EXPENSES:                                          |       |                                                       |       |                                                      |       |   |   |   |   |
| Cost of revenues (1)                                                   |       | 20,706                                                     |       | 23,507                                                    |       | 56,667 |   | 69,387 |   |
| Research and development (1)                                           |       | 7,678                                                      |       | 11,248                                                    |       | 22,477 |   | 32,114 |   |
| Selling and marketing (1)                                              |       | 8,873                                                      |       | 9,045                                                     |       | 25,328 |   | 27,531 |   |
| General and administrative (1)                                         |       | 7,872                                                      |       | 8,959                                                     |       | 20,828 |   | 27,702 |   |
| Depreciation and amortization of property  and equipment               |       | 1,869                                                      |       | 2,153                                                     |       | 5,192 |   | 6,433 |   |
| Amortization of intangible assets                                      |       | 5,105                                                      |       | 5,398                                                     |       | 13,728 |   | 16,310 |   |
| Loss on disposal of fixed assets                                       |       | —                                                     |       | 57                                                        |       | 2 |   | 83 |   |
| Total operating costs and expenses                                     |       | 52,103                                                     |       | 60,367                                                    |       | 144,222 |   | 179,560 |   |
| INCOME FROM OPERATIONS                                                 |       | 10,056                                                     |       | 15,187                                                    |       | 28,452 |   | 41,340 |   |
|                                                                   |       |                                                       |       |                                                      |       |   |   |   |   |
| INTEREST, DIVIDEND, INVESTMENT, AND OTHER  INCOME (EXPENSE), NET:      |       |                                                       |       |                                                      |       |   |   |   |   |
|                                                                   |       |                                                       |       |                                                      |       |   |   |   |   |
| Interest, dividend and investment income                               |       | 343                                                        |       | 686                                                       |       | 1,196 |   | 1,927 |   |
| Interest expense (Note 7)                                              |       | (9,702                                                     | )          | (5,546                                                    | )          | (27,394 | ) | (20,651 | ) |
| Other expenses (Note 7)                                                |       | —                                                     |       | —                                                    |       | — |   | (2,613 | ) |
| Total interest, dividend, investment, and  other income (expense), net |       | (9,359                                                     | )          | (4,860                                                    | )          | (26,198 | ) | (21,337 | ) |
| INCOME BEFORE PROVISION FOR INCOME TAXES                               |       | 697                                                        |       | 10,327                                                    |       | 2,254 |   | 20,003 |   |
| PROVISION FOR INCOME TAXES                                             |       | 244                                                        |       | 4,045                                                     |       | 1,056 |   | 7,828 |   |
| NET INCOME                                                             |       | $                                                          | 453        |                                                      | $          | 6,282 |   | $ | 1,198 |   | $ | 12,175 |   |
|                                                                   |       |                                                       |       |                                                      |       |   |   |   |   |
| NET INCOME PER SHARE:                                                  |       |                                                       |       |                                                      |       |   |   |   |   |
| Basic                                                                  |       | $                                                          | 0.01       |                                                      | $          | 0.10 |   | $ | 0.03 |   | $ | 0.20 |   |
| Diluted                                                                |       | $                                                          | 0.01       |                                                      | $          | 0.09 |   | $ | 0.02 |   | $ | 0.18 |   |
|                                                                   |       |                                                       |       |                                                      |       |   |   |   |   |
| WEIGHTED AVERAGE NUMBER OF COMMON SHARES  OUTSTANDING:                 |       |                                                       |       |                                                      |       |   |   |   |   |
|                                                                   |       |                                                       |       |                                                      |       |   |   |   |   |
| Basic                                                                  |       | 47,239,323                                                 |       | 60,780,651                                                |       | 45,960,089 |   | 59,493,052 |   |
| Diluted                                                                |       | 54,957,187                                                 |       | 68,409,343                                                |       | 54,024,994 |   | 67,040,711 |   |

 

----

(1) Includes stock-based compensation expense of:

 
| ** **                             | ** ** | **Three months ended   September 30,** | ** ** | **Nine months ended   September 30,** | ** ** |
|----------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                             | ** ** | **2007**                                                   | ** ** | **2008**                                                  | ** ** | **2007** | ** ** | **2008** | ** ** |
| ** **                             | ** ** | ** **                                                 | ** ** | ** **                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cost of revenues                       |       | $                                                          | 393        |                                                      | $          | 721 |   | $ | 968 |   | $ | 2,719 |   |
| Research and development expenses      |       | 311                                                        |       | 608                                                       |       | 971 |   | 2,060 |   |
| Selling and marketing expenses         |       | 298                                                        |       | 422                                                       |       | 851 |   | 1,375 |   |
| General and administrative expenses    |       | 412                                                        |       | 494                                                       |       | 1,165 |   | 1,468 |   |
| Total stock-based compensation expense |       | $                                                          | 1,414      |                                                      | $          | 2,245 |   | $ | 3,955 |   | $ | 7,622 |   |

 

See notes tocondensed consolidated financial statements.

 

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**RISKMETRICSGROUP, INC.**

 

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

**FORTHE NINE MONTHS ENDED SEPTEMBER 30, 2008**

 

**(UNAUDITED)**

 

**(Inthousands, except share amounts)**

 
| ** **                                                                                                              | ** ** | **Common Shares**                       | ** ** | ** ** | ** ** | **Additional**            | ** ** | **Accumulated   Other** | ** ** | ** **                    | ** ** | **Total**                      | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|------------|------------|---------------------------|------------|------------------------------|------------|-------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                              | ** ** | **Number of   Shares Issued** | ** ** | **Amount** | ** ** | **Treasury   Stock** | ** ** | **Paid-In   Capital**   | ** ** | **Comprehensive   Loss** | ** ** | **Accumulated   Deficit** | ** ** | **Stockholders’   Equity** | ** ** |
|                                                                                                                    |       |                                         |       |       |       |                      |       |                         |       |                          |       |                           |       |   |   |
| BALANCE—January 1, 2008                                                                                       |       | 47,850,652                                   |       | $          | 479        |                      | $          | (2                           | )          | $                             | 217,355    |                           | $          | (7,262 | ) | $ | (74,478 | ) | $ | 136,092 |   |
| Comprehensive income:                                                                                                   |       |                                         |       |       |       |                      |       |                         |       |                          |       |                           |       |   |   |
| Net income                                                                                                              |       | —                                       |       | —     |       | —                    |       | —                       |       | —                        |       | 12,175                         |       | 12,175 |   |
| Foreign currency translation adjustment                                                                                 |       | —                                       |       | —     |       | —                    |       | —                       |       | (1,027                        | )          | —                         |       | (1,027 | ) |
| Net unrealized gain on cash flow hedge, net  of deferred tax liability of $441 and realized loss (see disclosure below) |       | —                                       |       | —     |       | —                    |       | —                       |       | 684                           |       | —                         |       | 684 |   |
| Total comprehensive loss                                                                                                |       | —                                       |       | —     |       | —                    |       | —                       |       | —                        |       | —                         |       | 11,832 |   |
|                                                                                                                    |       |                                         |       |       |       |                      |       |                         |       |                          |       |                           |       |   |   |
| Common shares issued upon exercise of stock  options                                                                    |       | 1,526,692                                    |       | 15         |       | —                    |       | 5,664                        |       | —                        |       | —                         |       | 5,679 |   |
| Tax benefit associated with exercise of  stock options                                                                  |       | —                                       |       | —     |       | —                    |       | 5,075                        |       | —                        |       | —                         |       | 5,075 |   |
| Stock-based compensation                                                                                                |       | —                                       |       | —     |       | —                    |       | 7,622                        |       | —                        |       | —                         |       | 7,622 |   |
| Issuance of stock (Note 11)                                                                                             |       | 61,357                                       |       | —     |       | —                    |       | —                       |       | —                        |       | —                         |       | — |   |
| Common shares recovered in connection with  the acquisition of CFRA (Note 4)                                            |       | —                                       |       | —     |       | (577                      | )          | —                       |       | —                        |       | —                         |       | (577 | ) |
| Net proceeds from equity offering  (Note 3)                                                                        |       | 12,064,184                                   |       | 121        |       | —                    |       | 193,769                      |       | —                        |       | —                         |       | 193,890 |   |
|                                                                                                                    |       |                                         |       |       |       |                      |       |                         |       |                          |       |                           |       |   |   |
| BALANCE—September 30, 2008                                                                                    |       | 61,502,885                                   |       | $          | 615        |                      | $          | (579                         | )          | $                             | 429,485    |                           | $          | (7,605 | ) | $ | (62,303 | ) | $ | 359,613 |   |
|                                                                                                                    |       |                                         |       |       |       |                      |       |                         |       |                          |       |                           |       |   |   |
| Disclosure of realized loss:                                                                                            |       |                                         |       |       |       |                      |       |                         |       |                          |       |                           |       |   |   |
| Unrealized loss on cash flow hedge                                                                                      |       | $                                            | (3,073     | )          |       |                      |       |                         |       |                          |       |                           |       |   |   |   |
| Realized loss for cash flow hedge  settlement, net of tax benefit (Note 8)                                              |       | 3,757                                        |       |       |       |                      |       |                         |       |                          |       |                           |       |   |   |
| Net unrealized gain on cash flow hedge                                                                                  |       | $                                            | 684        |       |       |                      |       |                         |       |                          |       |                           |       |   |   |   |

 

See notes tocondensed consolidated financial statements.

 

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**RISKMETRICSGROUP, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**FOR THENINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2008**

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

 
| ** **                                                                                                                                            | ** ** | **2007**   | ** ** | **2008**   | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                                                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                                                                                       |       | $          | 1,198      |       | $          | 12,175 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities:                                                                    |       |       |       |       |       |
| Depreciation and amortization of property  and equipment                                                                                              |       | 5,192      |       | 6,433      |       |
| Provision for bad debts                                                                                                                               |       | 151        |       | 713        |       |
| Amortization of intangible assets                                                                                                                     |       | 13,728     |       | 16,310     |       |
| Amortization of debt issuance costs                                                                                                                   |       | 1,037      |       | 3,190      |       |
| Stock-based compensation                                                                                                                              |       | 3,955      |       | 7,622      |       |
| Tax benefit associated with exercise of  stock options                                                                                                |       | (201       | )          | (5,075     | )          |
| Loss on disposal of fixed assets                                                                                                                      |       | 2          |       | 83         |       |
| Changes in assets and liabilities:                                                                                                                    |       |       |       |       |       |
| Decrease (increase) in accounts receivable                                                                                                            |       | 914        |       | (12,507    | )          |
| Decrease (increase) in income and deferred  taxes                                                                                                     |       | (1,042     | )          | 11,330     |       |
| (Increase) decrease in other receivables  and prepaid expenses                                                                                        |       | (71        | )          | 72         |       |
| Increase in other assets                                                                                                                              |       | (1,567     | )          | (136       | )          |
| (Decrease) increase in deferred revenue                                                                                                               |       | (1,033     | )          | 14,258     |       |
| Decrease in trade accounts payable                                                                                                                    |       | (1,190     | )          | (2,875     | )          |
| (Decrease) increase in accrued expenses and  other liabilities                                                                                        |       | (3,812     | )          | 7,217      |       |
| Net cash provided by operating activities                                                                                                             |       | 17,261     |       | 58,810     |       |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                                                                                 |       |       |       |       |       |
| Purchases of property and equipment                                                                                                                   |       | (6,054     | )          | (5,804     | )          |
| Cash paid to acquire Institutional  Shareholder Services Inc. (“ISS”) and related acquisition costs (net of  cash acquired of $12,089) |       | (471,925   | )          | —     |       |
| Payment of acquired ISS acquisition related  costs                                                                                                    |       | (7,413     | )          | —     |       |
| Cash paid to acquire CFRA and related  acquisition cost (net of cash acquired $1,213)                                                                 |       | (45,904    | )          | 223        |       |
| Payment of deferred purchase price                                                                                                                    |       | (128       | )          | (127       | )          |
| Purchase of investments                                                                                                                               |       | (21,289    | )          | —     |       |
| Purchase of intangible asset                                                                                                                          |       | —     |       | (1,000     | )          |
| Proceeds from sale of investments                                                                                                                     |       | 89,364     |       | —     |       |
| Net cash used in investing activities                                                                                                                 |       | (463,349   | )          | (6,708     | )          |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                                                                                 |       |       |       |       |       |
| Proceeds from debt borrowings                                                                                                                         |       | 440,000    |       | —     |       |
| Repayment of debt                                                                                                                                     |       | (1,500     | )          | (132,131   | )          |
| Payment of debt issuance costs                                                                                                                        |       | (10,074    | )          | —     |       |
| Principal payments on capital lease  obligations                                                                                                      |       | (13        | )          | —     |       |
| Gross proceeds from equity offering (Note  3)                                                                                                         |       | —     |       | 197,400    |       |
| Equity offering expenses                                                                                                                              |       | —     |       | (1,581     | )          |
| Excess tax benefit associated with exercise  of stock options                                                                                         |       | 201        |       | 5,075      |       |
| Proceeds from exercise of stock options                                                                                                               |       | 5,427      |       | 5,679      |       |
| Repurchase of stock                                                                                                                                   |       | (2,239     | )          | —     |       |
| Net cash provided by financing activities                                                                                                             |       | 431,802    |       | 74,442     |       |
| EFFECT OF EXCHANGE RATE CHANGES ON CASH                                                                                                               |       | (10        | )          | (2,338     | )          |
| NET (DECREASE) INCREASE IN CASH AND CASH  EQUIVALENTS                                                                                                 |       | (14,296    | )          | 124,206    |       |
| CASH AND CASH EQUIVALENTS—Beginning of  period                                                                                                   |       | 37,313     |       | 27,455     |       |
| CASH AND CASH EQUIVALENTS—End of period                                                                                                          |       | $          | 23,017     |       | $          | 151,661 |   |
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW  INFORMATION:                                                                                                   |       |       |       |       |       |
| Cash paid for interest                                                                                                                                |       | $          | 26,602     |       | $          | 17,215 |   |
| Cash paid (refunded) for taxes                                                                                                                        |       | $          | 1,470      |       | $          | (4,907 | ) |
| NON CASH INVESTING AND FINANCING  ACTIVITIES:                                                                                                         |       |       |       |       |       |
| Issuance of common stock to purchase ISS                                                                                                              |       | $          | 42,426     |       | $          | — |   |
| Issuance of stock options to purchase ISS                                                                                                             |       | $          | 16,331     |       | $          | — |   |
| Retirement of treasury stock                                                                                                                          |       | $          | 103        |       | $          | — |   |
| Tax benefit associated with exercise of ISS  stock options                                                                                            |       | $          | 3,061      |       | $          | 616 |   |
| Issuance of common stock to purchase CFRA                                                                                                             |       | $          | 16,634     |       | $          | (577 | ) |

 

See notes tocondensed consolidated financial statements.

 

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**RISKMETRICS GROUP, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**FOR THETHREE AND NINE MONTHS ENDED SEPTEMBER 30, 2008**

**(UNAUDITED)**

 

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

 

**1. OVERVIEW AND BASIS OF PRESENTATION**

 

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

 

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

 

Theaccompanying unaudited condensed consolidated financial statements (the “financialstatements”) have been prepared pursuant to the rules of the Securitiesand Exchange Commission (the “SEC”). Certain information and footnotedisclosures normally included in financial statements prepared in accordancewith US GAAP have been condensed or omitted pursuant to SEC rules. Thesefinancial statements should be read in conjunction with the Company’s AnnualReport on Form 10-K for the year ended December 31, 2007.

 

The condensed consolidated financialstatements as of September 30, 2008 and for the three and nine monthsended September 30, 2007 and 2008 in the opinion of management, include alladjustments, consisting only of normal recurring accruals, necessary to presentfairly the Company’s financial position, results of operations and cash flows.The operating results for the three and nine months ended September 30,2008 are not necessarily indicative of the results to be expected for the fullyear.  The December 31, 2007condensed consolidated financial statement information has been derived fromthe 2007 audited consolidated financial statements.

 

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

 

***Use of Estimates and Significant AccountingPolicies****—*Thepreparation of condensed consolidated financial statements in conformity withUS GAAP requires management to make estimates, judgments and assumptions thataffect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the condensed consolidatedfinancial statements and the reported amounts of revenues and expenses duringthe reporting period. Significant estimatesand assumptions made by management include the deferral and recognition ofrevenue, impairment of goodwill and intangible assets, stock-basedcompensation, gains or losses on derivative instruments, accounting for incometaxes and other matters that affect the condensed consolidated financialstatements and related disclosures.  There have been no changes to theCompany’s significant accounting policies since December 31, 2007.The Company believes the estimates used in the preparation of the condensedconsolidated financial statements are reasonable; however, actual results coulddiffer from those estimates.

 

As disclosedin Note 2 of the Company’s audited financial statements included in its AnnualReport on Form 10-K for the year ended December 31, 2007,  goodwill is evaluated for impairment using atwo-step process that is performed at least annually on October 1 of each year,or whenever events or circumstances indicate that an impairment may haveoccurred.  Accordingly, the Company hascommenced its process for determining the estimated fair value of the ISSreporting unit, which is then compared to the ISS’s carrying value of ISS asthe first step of the annual goodwill impairment review process.  This estimated fair value of the reportingunit is based upon prices of similar groups of assets, market comparables orother valuation techniques including present value techniques based uponestimates of future cash flows.   TheCompany will complete its fair value assessment and goodwill impairment reviewduring the three months ended December 31, 2008 and the conclusion of suchreview could have a material impact on the consolidated financial statementsfor the year ending December 31, 2008.

 

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

 

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**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS, continued**

**FOR THETHREE AND NINE MONTHS ENDED SEPTEMBER 30, 2008**

 

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

 

On December 4, 2007, FASB issuedStatement No. 141(R), *BusinessCombinations* (SFAS 141(R)) and Statement No. 160, *Accounting and Reporting of Noncontrolling Interestsin Consolidated Financial Statements*, an amendment of ARB No. 51(SFAS 160). These new standards will significantly change the financialaccounting and reporting of business combination transactions andnoncontrolling (or minority) interests in consolidated financial statements.SFAS 141(R) is required to be adopted concurrently with Statement No. 160and is effective for business combination transactions for which theacquisition date is on or after the beginning of the first annual reportingperiod beginning on or after December 15, 2008. Early adoption isprohibited. Application of SFAS 141(R) and SFAS 160 is generallyrequired to be adopted prospectively, except for certain provisions of SFAS 141(R) andSFAS 160, which are required to be adopted retrospectively upon adoption.Business combination transactions accounted for before adoption ofSFAS 141(R) should be accounted for in accordance withSFAS141 and that accounting previously completed under SFAS 141 should notbe modified as of or after the date of adoption of Statement No.141(R). Theimpact of adopting SFAS 141R and SFAS 160 will be dependent on the businesscombinations that the Company may pursue after its effective date.

 

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

 

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

 

**3.  INITIAL PUBLIC OFFERING**

 

In January 2008, the Company completedan initial public offering of 16,100,000 shares of common stock, which included4,035,816 shares sold by selling stockholders and 2,100,000 shares to coverover-allotments, which was exercised in full in January 2008. The Companydid not receive any proceeds from the sale of the shares by the sellingstockholders.  Net proceeds from theoffering, including the exercise of the underwriters’ allotment, were$193.9 million, after deducting underwriting discounts and commissions andapproximately $3.5 million of offering expenses, of which $1.6 millionwere paid during the nine months ended September 30, 2008.   The Company utilized a portion of theproceeds to prepay the entire outstanding indebtedness under the Company’ssecond loan lien credit facility (See Note 7).

 

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**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS, continued**

**FOR THETHREE AND NINE MONTHS ENDED SEPTEMBER 30, 2008**

 

**4. ACQUISITIONS**

 

*Institutional Shareholder Services (“ISS”)Acquisition*

 

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

 

The aggregate consideration paid for theacquisition is as follows:

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

 

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

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

 

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

 
| Cash and cash equivalents and other current  assets |   | $       | 47,770  |   |
|-----------------------------------------------------|--------|---------|---------|--------|
| Property and equipment                              |   | 4,864   |    |
| Non-current assets                                  |   | 13,300  |    |
| Intangible assets                                   |   | 172,339 |    |
| Goodwill                                            |   | 418,563 |    |
| Total assets acquired                               |   | 656,836 |    |
| Accounts payable and accrued expenses               |   | (21,360 | )       |
| Deferred revenue                                    |   | (43,510 | )       |
| Other non-current liabilities                       |   | (1,533  | )       |
| Deferred tax liability                              |   | (47,662 | )       |
| Net assets acquired                                 |   | $       | 542,771 |   |
| Goodwill                                            |   | $       | 418,563 |   |
| Identifiable intangible assets                      |   | 172,339 |    |
| Deferred tax liability                              |   | (47,662 | )       |
| Net liabilities assumed                             |   | (469    | )       |
| Total purchase consideration                        |   | $       | 542,771 |   |

 

The goodwill and liabilitiesassumed have been adjusted during the three and nine months ended September 30,2008 to reflect certain liabilities for uncertain tax liabilities of ISS (seeNote 9).

 

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**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS, continued**

**FOR THETHREE AND NINE MONTHS ENDED SEPTEMBER 30, 2008**

 

In accordance with SFAS No. 109, *Accounting for Income Taxes*, the Companyhas provided for deferred taxes representing the difference between theestimated book and tax basis of the net assets acquired. The excess of thepurchase price over the estimated fair values of the assets acquired andliabilities assumed was allocated to goodwill, which is expected to bedeductible for tax purposes. The Company did not recognize a deferred tax assetrelating to the future tax deduction that will arise when the ISS employeerollover options are exercised. As such exercises occur, the Company recognizesa tax deduction and such benefit is recorded as a reduction of goodwill (Note5).

 

The amounts allocated to intangible assetsand acquired technology was attributed to the following categories and estimateduseful lives:

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

 

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

 

On August 1, 2007, the Company acquiredall of the outstanding membership interests of CFRA for $62,993. 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 the consolidatedfinancial statements since the date of its acquisition.

 

The aggregate consideration paid for theacquisition is as follows:

 
| Cash paid (includes cash acquired of  $1,213)       |   | $      | 46,275 |   |
|-----------------------------------------------------|--------|--------|--------|--------|
| Fair value of common stock issued (973,151  shares) |   | 16,057 |   |
| Transaction costs                                   |   | 661    |   |
| Total purchase consideration                        |   | $      | 62,993 |   |

 

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

 
| Cash and other current assets         |   | $      | 3,104  |   |
|---------------------------------------|--------|--------|--------|--------|
| Property and equipment                |   | 511    |   |
| Non-current assets                    |   | 49     |   |
| Intangible assets                     |   | 19,710 |   |
| Goodwill                              |   | 46,736 |   |
| Total assets acquired                 |   | 70,110 |   |
| Accounts payable and accrued expenses |   | (3,326 | )      |
| Deferred revenue                      |   | (3,791 | )      |
| Net assets acquired                   |   | $      | 62,993 |   |
| Goodwill                              |   | 46,736 |   |
| Identifiable intangible assets        |   | 19,710 |   |
| Net liabilities assumed               |   | (3,453 | )      |
| Total purchase consideration          |   | $      | 62,993 |   |

 

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**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS, continued**

**FOR THETHREE AND NINE MONTHS ENDED SEPTEMBER 30, 2008**

 

The amounts and useful lives allocated to intangibleassets were as follows:

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

 

The purchase consideration,goodwill and liabilities assumed have been adjusted during the three and ninemonths ended September 30, 2008 to reflect certain sales tax liabilitiesof CFRA (see Note 10).

 

**5. INTANGIBLE ASSETS AND GOODWILL**

 

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

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

 
| ** **              | ** ** | **September 30, 2008** | ** ** |
|-------------------------|------------|----------------------------------|------------|
| ** **              | ** ** | **Useful Lives**            | ** ** | **Gross** | ** ** | **Accumulated   Amortization** | ** ** | **Net** | ** ** |
| Customer relationships  |       | 7–11 years             |       | $ | 128,150 |   | $ | (20,635 | ) | $ | 107,515 |   |
| Acquired technology     |       | 5 years                     |       | 25,279 |   | (8,670 | ) | 16,609 |   |
| Covenant not to compete |       | 1–3 years              |       | 1,500 |   | (667 | ) | 833 |   |
| Proprietary process     |       | 7 years                     |       | 8,870 |   | (1,478 | ) | 7,392 |   |
| Trade names             |       | 1–10 years             |       | 22,800 |   | (4,005 | ) | 18,795 |   |
| Trade names             |       | Indefinite                       |       | 6,700 |   |   |   | 6,700 |   |
| Total                   |       |                             |       | $ | 193,299 |   | $ | (35,455 | ) | $ | 157,844 |   |

 

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 |   | $      | 5,369  |   |
|--------------------------------------------------|--------|--------|--------|--------|
| Years ending December 31,                   |   |   |   |
| 2009                                             |   | $      | 21,475 |   |
| 2010                                             |   | $      | 21,371 |   |
| 2011                                             |   | $      | 21,058 |   |
| 2012                                             |   | $      | 16,180 |   |

 

Goodwill changed during the nine months endedSeptember 30, 2008 as follows:

 
| Balance at January 1, 2008                                                                |   | $    | 460,951 |   |
|------------------------------------------------------------------------------------------------|--------|------|---------|--------|
| Tax benefit on exercise of stock options  granted to ISS employees on acquisition (See Note 4) |   | (616 | )       |
| Accrual of CFRA non-income tax liability  (Note 10)                                            |   | 638  |    |
| Accrual of ISS income tax contingency                                                          |   | 245  |    |
| Balance as of September 30, 2008                                                          |   | $    | 461,218 |   |

 

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**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS, continued**

**FOR THETHREE AND NINE MONTHS ENDED SEPTEMBER 30, 2008**

 

**6. ACCRUED EXPENSES**

 

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

 
| ** **                           | ** ** | **December 31,   2007** | ** ** | **September 30,   2008** | ** ** |
|--------------------------------------|------------|-----------------------------------|------------|------------------------------------|------------|
| Accrued compensation and related tax |       | $                                 | 28,490     |                               | $          | 27,010 |   |
| Accrued data expense                 |       | 1,133                             |       | 1,931                              |       |
| Accrued travel and entertainment     |       | 227                               |       | 608                                |       |
| Accrued professional fees            |       | 1,813                             |       | 1,778                              |       |
| Current portion of deferred rent     |       | 202                               |       | 348                                |       |
| CFRA sales tax liability (Note 10)   |       | —                            |       | 1,642                              |       |
| Other accrued expenses               |       | 2,324                             |       | 4,916                              |       |
|                                 |       | $                                 | 34,189     |                               | $          | 38,233 |   |

 

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

 

The second lien term loan facility was for$125 million and accumulated interest based on, at the option of theCompany at: (a) the LIBOR rate plus a margin of 5.50%, or (b) thehigher of (i) the Federal Funds Effective Rate plus 5.0% and (ii) Bankof America’s “prime rate,” plus a margin of 4.50%. In January 2008, theCompany utilized a portion of proceeds from the initial public offering toprepay the entire outstanding indebtedness under the second lien loan, in theamount of $125.0 million. In addition, the Company paid a 1% prepaymentpenalty fee, or $1.25 million, upon repayment as set forth in the creditagreement, which has been included in other expenses for the nine months ended September 30,2008 in the accompanying consolidated statements of income. In conjunction withthe repayment of the second lien loan during the nine months ended September 30,2008, the Company reduced the notional amount of the interest rate swap by$19.3 million, which resulted in other expense of $1.4 million in2008 (Note 8).  The effective interestrate on the Company’s debt was 8.74% and 7.37% for the nine months ended September 30,2007 and 2008, respectively.

 

In addition to quarterly interest paymentsdue on the credit facility, the Company is required to repay the principalamounts of the first lien credit facility in quarterly installments of $741, ofwhich the next payment is due on June 30, 2009. Furthermore, starting January 1,2008, the Company is required to make a mandatory payment equal to each year’sexcess cash flow depending on leverage ratios, as defined in the first lienterm loan facility, within five days of delivery of audited financialstatements. During the nine monthsended September 30, 2008, the Company made an excess cash flowprincipal payment of $6,381 for its first lien term loan. Based on theCompany’s consolidated leverage ratio as of September 30, 2008, no futureexcess cash flow payments would be required as long as that ratio ismaintained. The Company is required to repay the aggregate principal remainingon the first lien term loan facility on the maturity date. The Company mayvoluntarily prepay the first lien credit facilities in whole or in part withoutpenalty.

 

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**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS, continued**

**FOR THETHREE AND NINE MONTHS ENDED SEPTEMBER 30, 2008**

 

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

 
| For the twelve months ending  September 30, |   |    |    |
|--------------------------------------------------|--------|---------|---------|
| 2009                                             |   | $       | 1,483   |   |
| 2010                                             |   | 2,966   |    |
| 2011                                             |   | 2,966   |    |
| 2012                                             |   | 2,966   |    |
| 2013                                             |   | 2,966   |    |
| Thereafter                                       |   | 277,273 |    |
|                                             |   | $       | 290,620 |   |

 

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

 

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

 
| ** **                          | ** ** | **Three Months Ended   September 30,** | ** ** | **Nine Months Ended   September 30,** | ** ** |
|-------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                          | ** ** | **2007**                                                   | ** ** | **2008**                                                  | ** ** | **2007** | ** ** | **2008** | ** ** |
| Amortization of debt issuance costs |       | $                                                          | 360        |                                                      | $          | 260 |   | $ | 1,037 |   | $ | 3,190 |   |
|                                     |            |                                                            |            |                                                           |            |  |  |  |  |  |  |  |  |

 

**8. FAIR VALUE OF DERIVATIVE INSTRUMENTS**

 

EffectiveJanuary 1, 2008, the Company adopted the provisions of SFAS No. 157that apply to  financial assets andliabilities that are measured at fair value within the financial statements,which provides a framework for measuring fair value under GAAP. As defined inSFAS No. 157, fair value is the price that would be received to sell anasset or paid to transfer a liability in an orderly transaction between marketparticipants at the measurement date. The Company utilizes market data orassumptions that the Company believes market participants would use in pricingthe asset or liability, including assumptions about risk and the risks inherentin the inputs to the valuation technique. These inputs can be readilyobservable quoted prices in active markets for identical assets or liabilities(level 1), significant other observable inputs (level 2) or significantunobservable inputs (level 3).The Company primarily uses the income approach, which uses valuationtechniques to convert future amounts to a single present amount. As of September 30,2008 the Company had interest rate swap agreements which are valued using level2 inputs as shown in the following table:

 
| ** **                   | ** ** | ** ** | ** ** | **Fair value at September 30, 2008, using:** | ** ** |
|------------------------------|------------|------------|------------|----------------------------------------------------------------------------|------------|
| ** **                   | ** ** | ** ** | ** ** | **Quoted prices in**                                             | ** ** | **Significant** | ** ** | **Significant** | ** ** |
| ** **                   | ** ** | ** ** | ** ** | **active markets for**                                           | ** ** | **other** | ** ** | **unobservable** | ** ** |
| ** **                   | ** ** | ** ** | ** ** | **identical assets**                                                  | ** ** | **observable inputs** | ** ** | **inputs** | ** ** |
| ** **                   | ** ** | **Total**  | ** ** | **(Level 1)**                                                         | ** ** | **(Level 2)** | ** ** | **(Level 3)** | ** ** |
| Interest rate swap liability |       | $          | 9,865      |                                                                       | $          | — |   | $ | 9,865 |   | $ | — |   |
| Total                        |       | $          | 9,865      |                                                                       | $          | — |   | $ | 9,865 |   | $ | — |   |

 

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

 

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**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS, continued**

**FOR THETHREE AND NINE MONTHS ENDED SEPTEMBER 30, 2008**

 

The Company’s interest-rate swap agreementshedge a substantial portion of the interest rate risk exposure under theCompany’s debt (see Note 7). As of December 31, 2007 and September 30,2008, the swap agreements had a notional amount of $317,063 and $279,938,respectively. As of December 31, 2007 and September 30, 2008, theswap agreements had a fair value liability of $10,990 and $9,865, respectively,which is included in other long-term liabilities on the accompanyingconsolidated balance sheets.

 

In conjunction with the prepayment of thesecond lien loan during the nine months ended September 30, 2008 (Note 7),the Company 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 nine monthsended September 30, 2008.

 

The notional amount of the swap amortizesover the life of the debt and results in gains and losses being recognized ininterest expense in the accompanying consolidated statements of income. Thegain (loss) from the amortization of the swap agreement is summarized in thefollowing table:

 
| ** **                      | ** ** | **Three Months Ended   September 30,** | ** ** | **Nine Months Ended   September 30,** | ** ** |
|---------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                      | ** ** | **2007**                                                   | ** ** | **2008**                                                  | ** ** | **2007** | ** ** | **2008** | ** ** |
| Gain (loss) from swap agreement |       | $                                                          | 212        |                                                      | $          | (1,648 | ) | $ | 514 |   | $ | (3,562 | ) |
|                                 |            |                                                            |            |                                                           |            |  |  |  |  |  |  |  |  |

 

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 September 30, 2008. To theextent that the agreement is not considered to be highly effective inoffsetting the change in the value of the interest payments being hedged, thefair value relating to the ineffective portion of such agreement and anysubsequent changes in such fair value will be immediately recognized inearnings. To the extent that the agreement is considered highly effective butnot completely effective in offsetting the change in the value of the interestpayments being hedged, any changes in fair value relating to the ineffectiveportion of such agreement will be immediately recognized in earnings. Effectivegains and losses have been included in the unrealized gain on cash flow hedgesas a component of other comprehensive income (loss) net of tax.

 

**9. INCOME TAXES**

 

*Income taxes*

 

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

 
| ** **                                                               | ** ** | **Nine months ended   September 30,** | ** ** |
|--------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                               | ** ** | **2007**                                                  | ** ** | **2008** | ** ** |
| Tax provision, at U.S. Federal statutory  tax rate                       |       | 35.0                                                      | %          | 35.0 | % |
| State and local income tax (benefit)  expense, net of U.S. federal taxes |       | (3.3                                                      | )%         | 3.6 | % |
| Non-deductible stock option expense under  SFAS 123(R)              |       | 24.2                                                      | %          | 1.0 | % |
| Other                                                                    |       | (9.1                                                      | )%         | (0.5 | )% |
| Net tax provision                                                        |       | 46.8                                                      | %          | 39.1 | % |

 

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

 

14

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**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS, continued**

**FOR THETHREE AND NINE MONTHS ENDED SEPTEMBER 30, 2008**

 

*FIN 48*

 

As of September 30, 2008, the Company’sunrecognized tax benefits totaled $1,757, of which $782 would favorably impactthe Company’s effective tax rate, if recognized. The remaining $975 ofliability for unrecognized tax benefits represents tax liabilities establishedprior to January 11, 2007 which impacted the goodwill of the Company. Overthe next three months, an increase of $107 will be recorded for unrecognizedtax benefits and such increase will unfavorably impact the Company’s income taxprovision.  Interest and penaltiesaccrued during the nine months ended September 30, 2007 and 2008 were notsignificant.

 

The Company’s tax returns for 2004-2007 remainopen to examination by the Internal Revenue Service in their entirety. Theyalso remain open with respect to international and state taxingjurisdictions.  Currently, the companyhas been selected for audit by the Internal Revenue Service for 2006, New YorkCity for 2004-2006 and Canada Revenue Agency for 2005-2006.  As of September 30, 2008, $414 wasaccrued 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 |   | 182 |   |
| Additions for tax positions of prior years                    |   | 438 |   |
| Reductions for tax positions of prior years                   |   | (52 | )      |
| Balance as of September 30, 2008                         |   | $   | 1,757  |   |

 

**10. COMMITMENTS AND CONTINGENCIES**

 

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

 
| For the twelve months ending  September 30, |   |   |   |
|--------------------------------------------------|--------|--------|--------|
| 2009                                             |   | $      | 6,371  |   |
| 2010                                             |   | 6,131  |   |
| 2011                                             |   | 5,506  |   |
| 2012                                             |   | 4,661  |   |
| 2013                                             |   | 1,019  |   |
| Thereafter                                       |   | 171    |   |
| Total minimum lease payments                     |   | $      | 23,859 |   |

 

Duringthe nine months ended September 30, 2008, the Company incurred a $198lease exit cost as a result of relocating the Company’s London operations andsuch expense has been included in general and administrative expenses in theaccompanying statement of income.

 

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

 
| For the twelve months ending  September 30, |   |   |   |
|--------------------------------------------------|--------|--------|--------|
| 2009                                             |   | $      | 7,163  |   |
| 2010                                             |   | 2,326  |   |
| 2011                                             |   | 415    |   |
| Total                                            |   | $      | 9,904  |   |

 

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

 

15

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**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS, continued**

**FOR THETHREE AND NINE MONTHS ENDED SEPTEMBER 30, 2008**

 

During 2008, the Company completed an internal study whichdetermined certain sales tax liabilities are payable in connection with boththe pre-acquisition and post-acquisition operational activity of CFRA.   The maximum cost of this contingency isestimated to be approximately $1,746 however, the Company believes the probablecost to be approximately $1,642 of which $1,438 relates to pre-acquisitionactivity.   The Company has recovered$800 pursuant to an escrow agreement with the former equity owners of CFRA,comprised of $223 in cash and $577 in shares of the Company’s common stock, andhas recorded the recovery as a reduction to the CFRA purchase price (See Note4).   The Company expects to furtheranalyze and refine this estimated liability and resolve the matter by December 31,2008.  Accordingly, $204 of expense hasbeen recorded in general and administrative expenses within the accompanyingconsolidated statement of income for the nine months ended September 30,2008, and $638 has been recorded as an adjustment to CFRA goodwill (See Note5).

 

**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 September 30,2008, 5,664,450 options issued under the 2000 Plan remain outstanding.

 

The 2004 Plan provides for the grant ofoptions to employees, consultants, and non-employee directors to purchasecommon stock, which vest over a three to four year period and have a ten-yearcontractual term. To satisfy options granted under the Plan, the Company maymake common stock available from authorized but unissued shares or shares heldin treasury by the Company. The maximum number of shares of the Company’scommon stock available for issuance under the 2004 Plan is 7,500,000.Subsequent to the acquisition of ISS, the Company retired the 2004 plan andadopted a new option plan (the “2007 plan”). As of September 30, 2008,4,473,343 options issued under the 2004 Plan remain outstanding.

 

In January 2007, the Company’s Board ofDirectors adopted a stock option plan covering the employees from ISS (the “ISSPlan”), which resulted in the rollover of 1,396,000 fully-vested options. Underthe adoption of this ISS Plan, no additional options are to be issued. As of September 30,2008, 161,442 options issued under the ISS Plan remain outstanding.

 

In January 2007 the Company’s Board ofDirectors adopted a Stock Option Plan (the “2007 Plan”) that provides for thegrant of options and non-vested stock to employees, consultants, andnon-employee directors to purchase common stock, which vest over a four yearperiod and have a ten-year contractual term. The maximum number of shares ofthe Company’s common stock available for issuance under the 2007 Plan is 6,500,000.As of September 30, 2008, 2,681,915 options and 326,433 shares ofnon-vested stock granted under the 2007 Plan remain outstanding.

 

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

 
| ** **                               | ** ** | **Number of   Shares** | ** ** | **Weighted-   Average   Exercise   Price** | ** ** |
|------------------------------------------|------------|----------------------------------|------------|-----------------------------------------------------------|------------|
| Outstanding—January 1, 2008    |       | 13,361,282                       |       | $                                                         | 5.79       |   |
| Granted*                                 |       | 1,626,500                        |       | $                                                         | 17.52      |   |
| Exercised                                |       | (1,526,692                       | )          | $                                                         | 3.72       |   |
| Forfeited                                |       | (479,940                         | )          | $                                                         | 15.30      |   |
| Outstanding—September 30, 2008 |       | 12,981,150                       |       | $                                                         | 7.16       |   |

 

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**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS, continued**

**FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER30, 2008**

 

----

*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 63,000 options subsequent tothe initial public offering at various times during 2008.

 

The Company’s stock options outstanding as of September 30, 2008were as follows:

 
| ** **          | ** ** | **Outstanding Options** | ** ** | **Options Exercisable**                       | ** ** |
|---------------------|------------|------------------------------|------------|----------------------------------------------------|------------|
| **Exercise  Price** | ** ** | **Number of  Options**  | ** ** | **Weighted-Average  Remaining  Contractual  Life** | ** ** | **Weighted-Average  Exercise  Price** | ** ** | **Number of  Options** | ** ** | **Weighted-Average  Exercise  Price** | ** ** |
| ** **          | ** ** | ** **                   | ** ** | **(In Years)**                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| $                   | 1.20       |                         | 916,913    |                                               | 2.33       |   | $ | 1.20 |   | 916,913 |   | $ | 1.20 |   |
| 1.49                |       | 83,499                       |       | 3.19                                               |       | 1.49 |   | 83,499 |   | 1.49 |   |
| 2.00                |       | 3,009,353                    |       | 4.01                                               |       | 2.00 |   | 3,009,351 |   | 2.00 |   |
| 2.33                |       | 4,505                        |       | 4.41                                               |       | 2.33 |   | 4,505 |   | 2.33 |   |
| 2.40                |       | 1,738,184                    |       | 5.26                                               |       | 2.40 |   | 1,722,559 |   | 2.40 |   |
| 3.42                |       | 20,365                       |       | 5.08                                               |       | 3.42 |   | 20,365 |   | 3.42 |   |
| 3.75                |       | 234,525                      |       | 5.94                                               |       | 3.75 |   | 230,775 |   | 3.75 |   |
| 4.46                |       | 15,141                       |       | 6.01                                               |       | 4.46 |   | 15,141 |   | 4.46 |   |
| 4.80                |       | 1,238,020                    |       | 6.28                                               |       | 4.80 |   | 896,773 |   | 4.80 |   |
| 5.05                |       | 17,837                       |       | 6.60                                               |       | 5.05 |   | 17,837 |   | 5.05 |   |
| 5.94                |       | 20,095                       |       | 7.37                                               |       | 5.94 |   | 20,095 |   | 5.94 |   |
| 6.00                |       | 241,262                      |       | 6.85                                               |       | 6.00 |   | 185,951 |   | 6.00 |   |
| 7.20                |       | 1,701,772                    |       | 7.31                                               |       | 7.20 |   | 805,343 |   | 7.20 |   |
| 15.29               |       | 2,134,014                    |       | 8.44                                               |       | 15.29 |   | 532,554 |   | 15.29 |   |
| 16.50               |       | 123,165                      |       | 7.96                                               |       | 16.50 |   | 35,583 |   | 16.50 |   |
| 17.50               |       | 1,472,500                    |       | 9.31                                               |       | 17.50 |   | 212,000 |   | 17.50 |   |
| 19.95               |       | 10,000                       |       | 9.64                                               |       | 19.95 |   | — |   | 19.95 |   |
|                |       | 12,981,150                   |       | 6.17                                               |       | $ | 7.16 |   | 8,709,244 |   | $ | 4.16 |   |
|                     |            |                              |            |                                                    |            |  |  |  |  |  |  |  |  |  |

 

Of the unvested options as of September 30,2008, 3,759,277 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   September 30,** | ** ** | **Nine Months Ended   September 30,** | ** ** |
|---------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                      | ** ** | **2007**                                                   | ** ** | **2008**                                                  | ** ** | **2007** | ** ** | **2008** | ** ** |
| Risk-free interest rate         |       | 4.6                                                        | %          | 3.2                                                       | %          | 4.7 | % | 2.6 | % |
| Expected term (in years)        |       | 4.5                                                        |       | 4.5                                                       |       | 4.5 |   | 4.5 |   |
| Expected stock price volatility |       | 29                                                         | %          | 35                                                        | %          | 29 | % | 35 | % |
| Expected dividend yield         |       | None                                                       |       | None                                                      |       | None |   | None |   |

 

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

 
| ** **                                                | ** ** | **Three Months Ended   September 30,** | ** ** | **Nine Months Ended   September 30,** | ** ** |
|-----------------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                | ** ** | **2007**                                                   | ** ** | **2008**                                                  | ** ** | **2007** | ** ** | **2008** | ** ** |
| Weighted average per share fair value of  options granted |       | $                                                          | 5.36       |                                                      | $          | 5.81 |   | $ | 5.02 |   | $ | 5.81 |   |
|                                                           |            |                                                            |            |                                                           |            |  |  |  |  |  |  |  |  |

 

17

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**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS, continued**

**FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER30, 2008**

 

*Non-vested Stock*

 

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

 
| ** **                                 | ** ** | **Number of   Shares** | ** ** | **Weighted Average   Grant Date   Fair Value** | ** ** |
|--------------------------------------------|------------|----------------------------------|------------|-------------------------------------------------------------------------|------------|
| Unvested shares at January 1, 2008    |       | 346,609                          |       | $                                                                       | 16.50      |   |
| Granted                                    |       | 53,908                           |       | $                                                                       | 22.00      |   |
| Vested                                     |       | (61,357                          | )          | $                                                                       | 16.50      |   |
| Forfeited                                  |       | (12,727                          | )          | $                                                                       | 16.50      |   |
| Unvested Shares at September 30, 2008 |       | 326,433                          |       | $                                                                       | 17.88      |   |

 

As of September 30, 2008, there wasapproximately $18,025 of unrecognized compensation costs related to stockoptions and non-vested share-based compensation awards granted under the stockoption plans, which is expected to be recognized over a period of approximatelyfour years.

 

**12. EARNINGS PER SHARE**

 

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

 

In computing earnings per share for the threeand nine months ended September 30, 2007 and 2008, the difference betweenbasic and diluted number of shares outstanding is as follows:

 
| ** **                                                                       | ** ** | **Three Months Ended   September 30,** | ** ** | **Nine Months Ended   September 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                                       | ** ** | **2007**                                                   | ** ** | **2008**                                                  | ** ** | **2007** | ** ** | **2008** | ** ** |
| Basic number of weighted-average shares  outstanding                             |       | 47,239,323                                                 |       | 60,780,651                                                |       | 45,960 ,089 |   | 59,493,052 |   |
| Effect of dilutive securities— Employee  stock options and non-vested stock |       | 7,717,864                                                  |       | 7,628,692                                                 |       | 8,064,905 |   | 7,547,659 |   |
| Diluted number of weighted-average shares  outstanding                           |       | 54,957,187                                                 |       | 68,409,343                                                |       | 54,024,994 |   | 67,040,711 |   |

 

Options and non-vested stock of 2,930,355 and2,568,962 common shares during the three months ended September 30, 2007and 2008, and 1,988,656 and 1,560,000 common shares for the nine months ended September 30,2007 and 2008, respectively, were anti-dilutive and were therefore excludedfrom the computation of diluted earnings per share.

 

**13. SEGMENT INFORMATION**

 

As of September 30, 2008, the Companyhas two reportable segments, the RiskMetrics business and the ISS business.These designations have been made as the discrete operating results of thesesegments are reviewed by the Company’s chief operating decision maker to assessperformance and make operating and asset allocation decisions. The Companyallocates corporate and other shared services to each segment based on theemployees’ geographic location and headcount. Goodwill and intangible assetsacquired in connection with the ISS and CFRA acquisitions are included in theISS 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

 

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**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS, continued**

**FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER30, 2008**

 

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

 

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

 

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

 
| ** **                                               | ** ** | **RiskMetrics   Business** | ** ** | **ISS   Business** | ** ** | **Total** | ** ** |
|----------------------------------------------------------|------------|---------------------------------|------------|-------------------------|------------|-----------|------------|
| **Three months ended September 30, 2007:**          |       |                            |       |                    |       |      |       |
| Revenues                                                 |       | $                               | 30,968     |                    | $          | 31,191    |       | $ | 62,159 |   |
| Depreciation and amortization of property  and equipment |       | 1,116                           |       | 753                     |       | 1,869     |       |
| Amortization of intangible assets                        |       | —                          |       | 5,105                   |       | 5,105     |       |
| Other operating expenses                                 |       | 21,379                          |       | 23,750                  |       | 45,129    |       |
| Income from operations                                   |       | $                               | 8,473      |                    | $          | 1,583     |       | $ | 10,056 |   |
| Interest, dividend and investment income                 |       |                            |       |                    |       | 343       |       |
| Interest expense                                         |       |                            |       |                    |       | (9,702    | )          |
| Income before income taxes                               |       |                            |       |                    |       | 697       |       |
| Provision for income taxes                               |       |                            |       |                    |       | 244       |       |
| Net income                                               |       |                            |       |                    |       | $         | 453        |   |
| Asset information at September 30,  2007:           |       |                            |       |                    |       |      |       |
| Segment assets                                           |       | $                               | 57,270     |                    | $          | 710,265   |       | $ | 767,535 |   |
| Goodwill                                                 |       | $                               | —     |                    | $          | 467,275   |       | $ | 467,275 |   |

 
| ** **                                               | ** ** | **RiskMetrics   Business** | ** ** | **ISS   Business** | ** ** | **Total** | ** ** |
|----------------------------------------------------------|------------|---------------------------------|------------|-------------------------|------------|-----------|------------|
| **Three months ended September 30, 2008:**          |       |                            |       |                    |       |      |       |
| Revenues                                                 |       | $                               | 40,846     |                    | $          | 34,708    |       | $ | 75,554 |   |
| Depreciation and amortization of property  and equipment |       | 1,152                           |       | 1,001                   |       | 2,153     |       |
| Amortization of intangible assets                        |       | —                          |       | 5,398                   |       | 5,398     |       |
| Other operating expenses                                 |       | 27,438                          |       | 25,378                  |       | 52,816    |       |
| Income from operations                                   |       | $                               | 12,256     |                    | $          | 2,931     |       | $ | 15,187 |   |
| Interest, dividend and investment income                 |       |                            |       |                    |       | 686       |       |
| Interest expense                                         |       |                            |       |                    |       | (5,546    | )          |
| Income before income taxes                               |       |                            |       |                    |       | 10,327    |       |
| Provision for income taxes                               |       |                            |       |                    |       | 4,045     |       |
| Net income                                               |       |                            |       |                    |       | $         | 6,282      |   |
| Asset information at September 30,  2008:           |       |                            |       |                    |       |      |       |
| Segment assets                                           |       | $                               | 174,162    |                    | $          | 675,471   |       | $ | 849,633 |   |
| Goodwill                                                 |       | —                          |       | $                       | 461,218    |      | $          | 461,218 |   |

 
| ** **                                               | ** ** | **RiskMetrics   Business** | ** ** | **ISS   Business** | ** ** | **Total** | ** ** |
|----------------------------------------------------------|------------|---------------------------------|------------|-------------------------|------------|-----------|------------|
| **Nine months ended September 30, 2007:**           |       |                            |       |                    |       |      |       |
| Revenues                                                 |       | $                               | 87,704     |                    | $          | 84,970    |       | $ | 172,674 |   |
| Depreciation and amortization of property  and equipment |       | 3,286                           |       | 1,906                   |       | 5,192     |       |
| Amortization of intangible assets                        |       | —                          |       | 13,728                  |       | 13,728    |       |
| Other operating expenses                                 |       | 62,649                          |       | 62,653                  |       | 125,302   |       |
| Income from operations                                   |       | $                               | 21,769     |                    | $          | 6,683     |       | $ | 28,452 |   |
| Interest, dividend and investment income                 |       |                            |       |                    |       | 1,196     |       |
| Interest expense                                         |       |                            |       |                    |       | (27,394   | )          |
| Income before income taxes                               |       |                            |       |                    |       | 2,254     |       |
| Provision for income taxes                               |       |                            |       |                    |       | 1,056     |       |
| Net income                                               |       |                            |       |                    |       | $         | 1,198      |   |

 

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**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS, continued**

**FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER30, 2008**

 
| ** **                                               | ** ** | **RiskMetrics   Business** | ** ** | **ISS   Business** | ** ** | **Total** | ** ** |
|----------------------------------------------------------|------------|---------------------------------|------------|-------------------------|------------|-----------|------------|
| **Nine months ended September 30, 2008:**           |       |                            |       |                    |       |      |       |
| Revenues                                                 |       | $                               | 114,110    |                    | $          | 106,790   |       | $ | 220,900 |   |
| Depreciation and amortization of property  and equipment |       | 3,496                           |       | 2,937                   |       | 6,433     |       |
| Amortization of intangible assets                        |       | —                          |       | 16,310                  |       | 16,310    |       |
| Other operating expenses                                 |       | 76,967                          |       | 79,850                  |       | 156,817   |       |
| Income from operations                                   |       | $                               | 33,647     |                    | $          | 7,693     |       | $ | 41,340 |   |
| Interest, dividend and investment income                 |       |                            |       |                    |       | 1,927     |       |
| Interest expense                                         |       |                            |       |                    |       | (20,651   | )          |
| Other expenses                                           |       |                            |       |                    |       | (2,613    | )          |
| Income before income taxes                               |       |                            |       |                    |       | 20,003    |       |
| Provision for income taxes                               |       |                            |       |                    |       | 7,828     |       |
| Net income                                               |       |                            |       |                    |       | $         | 12,175     |   |

 

**14. RELATED PARTY TRANSACTION**

 

In May 2008, the Company entered into a contract for the sale ofMarket Risk products to Duff Capital Advisors. Philip Duff, a director of theCompany, is the founder, CEO and General Partner of Duff Capital Advisors. TheCompany recognized revenue of $252 and $422 for the Duff Capital Advisorscontract for the three and nine months ended September 30, 2008,respectively.

 

**15. SUBSEQUENT EVENT**

 

On October 3, 2008 the Company acquired all of the outstandingstock of Applied4 Technology Ltd. (“Applied 4”) for approximately $1.7 millionin cash.  Additional purchase priceconsideration ranging from approximately $1.7 million to $2.1 million may bepaid for the acquisition of Applied 4 if certain earning targets are achievedfrom the fiscal years 2009 through 2011. The purpose of this acquisition was to broaden the performanceattribution analytical tools  the Companycan offer to its clients.

 

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

 

*Unless the context otherwise indicates or requires,as used in this Form 10-Q, references to “we,” “us,” “our” or the “company”refer to RiskMetrics Group, Inc., and its subsidiaries. References to “RiskMetrics”refer only to our subsidiary, RiskMetrics Solutions, Inc. and itssubsidiaries, references to “ISS” refer only to our subsidiary InstitutionalShareholder Services, Inc. and its subsidiaries, and references to “CFRA”refer only to RMG-CFRA, LLC, formerly CFRA Holdings, LLC, and itssubsidiary (which have been merged into ISS).. In this Form 10-Q, all dollar amounts are expressed in thousands,unless indicated otherwise. References to our “clients” include each businessunit, division or wholly-owned subsidiary of a parent company which has enteredinto a separate customer contract with us.*

 

*Thefollowing discussion and analysis of the financial condition and resultsof operations should be read in conjunction with the consolidatedfinancial statements and related notes included elsewhere in this Form 10-Qand in our Annual Report on Form 10-K for the year ended December 31,2007 (the “Form 10-K”). This discussion contains forward-lookingstatements that involve risks and uncertainties. Our actual results coulddiffer materially from those discussed below. Factors that could cause orcontribute 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 management and corporate governanceproducts and services to participants in the global financial markets, asmeasured by revenues. Our products and services enable investors to measure andmanage the market, credit, portfolio, governance, accounting, legal andenvironmental risks associated with their financial holdings. These offeringsaddress multiple asset classes, markets and geographies to a broad group ofmarket participants, including asset managers, hedge funds, pension funds,banks, insurance companies, financial advisors and corporations. Clients relyon us to better understand and manage risk of their financial holdings, toprovide greater transparency to both their internal and externalconstituencies, to satisfy regulatory and reporting requirements and to makebetter investment decisions.

 

Our growth strategy is focused on the following:

 

·                  increasing sales to existingclients by providing additional data, research, analytical products andprocessing services, which we believe will be enhanced by leveraging ourcombined RiskMetrics and ISS sales forces;

 

·                  expanding our client base byfurther penetrating our markets, including expanding our global footprint andattracting new clients, especially financial institutions which currently relyon internally developed risk management and proxy voting solutions; and

 

·                  enhancing and extending ourproducts and services, including the creation of new product and serviceofferings and by selectively pursuing acquisitions; while leveraging theeconomies of scale in our cost structure to grow revenues at a greater ratethan operating expenses and thereby increase our operating margin.

 

We benefit from a number of favorable attributes 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 93.6% of our total revenues during the nine monthsended September 30, 2008, and we had a renewal rate of 88.5% during thattime. Our subscription model and high renewal rates minimize volatility in ourrevenues and provide significant visibility for our future results.

 

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

 

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

 

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In evaluating our results, we focus on several key financial andoperating data including annualized contract value, renewal rates, sales to newcustomers, non-recurring revenues and Adjusted EBITDA. Our annualized contractvalue, which is described in detail below, is a leading indicator of ourbusiness and represents a large portion of our revenue in any given period. Wetrack our performance across geographies and product and service lines.

 

We expect to invest in our business to continue to grow our revenues.Compensation, data acquisition and technology infrastructure costs representsignificant components of our operating expense structure. While we expect toincrease our operating expenses over time to take advantage of marketopportunities, we believe that the economies of scale in our operating modelwill allow us to grow our operating expenses at a lower rate than revenues andthereby increase our operating margins.

 

The vast majority of ourbusiness involves the sale of products and services to clients in thefinancial services industry including asset managers, banks, insurancecompanies, hedge funds, pension funds as well as professionalorganizations that serve the financial services industry.  The globalfinancial markets have been adversely impacted by the current marketenvironment that includes illiquidity, market volatility, wideningcredit spreads, changes in interest rates, currency exchange fluctuations andnew legal and compliance requirements.  These market conditionsand the reduced business activity have had a negative impact on anumber of our clients and could negatively impact our future revenues due tothe potential for declining sales and renewal rates.

 

We do not believe thatour liquidity has been affected by the recent events in the global financialmarkets.  Refer to Liquidity and CapitalResources discussion.

 

***Our Revenues***

 

We generate a substantial majority of our revenues from annualsubscriptions to our products and services, for which our clients generally payus in advance. These contracts generally renew automatically on an annualbasis. Our products and services are generally priced based on the access toour 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 directly 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 are referred to as recurringrevenues. Recurring revenues are generated through the renewal of existingcontracts and the signing of new subscription contracts. For the nine monthsended September 30, 2008, approximately 93.6% of our total revenues weregenerated from these subscription contracts. The subscription fees receivedfrom our clients are recorded as deferred revenues and recognized each month asour services are rendered. Our renewal rate, which was 88.5% for the ninemonths ended September 30, 2008, combined with our level of newsubscription contracts, determine our annualized contract value, which is aleading indicator of our recurring revenues. Our annualized contract value asof September 30, 2008 was $288,089.

 

We also generate non-recurring revenue from sales of products andservices without a subscription contract, which represented 6.4% of total revenuesduring the nine months ended September 30, 2008.

 

*Annualized Contract Value (“ACV”)*

 

As a result of our subscription-based model and high renewal rates, atthe end of any period, we generally have subscription contracts in place for ahigh percentage of our total revenues for the next 12 months. We monitorthe contracted revenues from these agreements and refer to them as annualizedcontract value. We define our annualized contract value as the aggregate valueon an annualized basis of all recurring subscription contracts in effect on areporting date. Any revenues associated with subscription contracts that areentered into during a reporting period will be reflected in the annualizedcontract value beginning at the end of that period. As a result, annualizedcontract value at the end of any period is the annualized contract value at thebeginning of the period plus the annualized contract revenue associated withnew subscription contracts signed during that period minus the annualizedcontract revenues associated with subscription contracts not renewed.Annualized contract value does not include any fees associated with anynon-recurring revenues.

 

Annualized contract value is an important metric for our business.However, annualized contract value may differ from our future reported revenuesdue to a number of factors, which include:

 

·                  new subscription-basedrevenues;

 

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·                  additional one-time revenue;

 

·                  changes in the contractvalue of our subscription contracts;

 

·                  cancellations andnon-renewals of subscription contracts; and

 

·                  revenue recognition timingdifferences due to the provisions of generally accepted accounting principlesin the United States (“ U.S. GAAP”).

 

Our annualized contract value for the RiskMetrics business and ISSbusiness as of September 30, 2007, June 30, 2008, and September 30,2008, as well as the percentage growth period over period is set forth,separately for each business, in the tables below.

 

**Year-Over-Year Comparison**

 
| ** **                                     | ** ** | **As of September 30,** | ** ** |
|------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                     | ** ** | **2007**                               | ** ** | **2008** | ** ** |
| RiskMetrics business annualized contract value |       | $                                      | 123,463    |   | $ | 159,603 |   |
| Percent growth                                 |       |                                   | * *   | 29.3 | % |
| ISS business annualized contract value         |       | $                                      | 117,450    |   | $ | 128,486 |   |
| Percent growth                                 |       |                                   | * *   | 9.4 | % |

 

**Sequential Comparison**

 
| ** **                                                         | ** ** | **As of June 30, 2008** | ** ** | **As of September  30, 2008** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------------|------------|----------------------------------------------|------------|
| RiskMetrics business annualized contract value |       | $                                           | 155,435    |                                         | $          | 159,603 |   |
| Percent growth                                                     |       |                                        | * *   | 2.7                                          | %          |
| ISS business annualized contract value                             |       | $                                           | 126,411    |                                         | $          | 128,486 |   |
| Percent growth                                                     |       |                                        | * *   | 1.6                                          | %          |

 

*Renewal Rate*

 

Because non-renewals of subscription contracts decrease our annualizedcontract value, which in turn decreases our revenues, a key operating metric isrenewal rate. Our renewal rate for any period is defined as the amount ofannualized contract value that renews in a period divided by the amount ofannualized contract value with an expiration date during that period. If aclient has a higher contract value upon renewal of its existing contract, theamount in excess of the prior period’s contract is considered new contractrevenue for purposes of this calculation.

 

The renewal rate for our RiskMetrics business and ISS business for thenine months ended September 30, 2007 and 2008, is set forth separately foreach business, in the table below.

 
| ** **                        | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------|------------|-----------------------------------------------------|------------|
| ** **                        | ** ** | **2007**                                            | ** ** | **2008** | ** ** |
| RiskMetrics business renewal rate |       | 90.1                                                | %          | 88.9 | % |
| ISS business renewal rate         |       | 91.1                                                | %          | 88.0 | % |

 

The RiskMetrics renewal rate declined mainly due to a lower renewalrate in the alternative investment segment.  The ISS renewal rate declined dueto lower renewal rates in the Corporate business and the inclusion of CFRAin 2008, which historically has lower average renewal rates than other ISSproducts.

 

*Non-Recurring Revenues*

 

Non-recurring revenues result from sales on a non-subscription basis.Non-recurring revenues for the RiskMetrics business and ISS business for thethree and nine months ended September 30, 2007 and 2008 are set forth inthe 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 

 

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subscriptionservice is provided, some Compensation Advisory Services revenues arerecognized over a three month period and other non-recurring revenues arerecognized once the service is provided. To the extent that clients’ actualusage of proxy voting services or proxy research reports exceeds contracted-forlimits, the excess usage is considered to be an overage and clients are chargedadditional fees. Our clients’ overages are typically an indication of largerproxy voting contract renewals.

 
| ** **                                         | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                         | ** ** | **2007**                                             | ** ** | **2008**                                            | ** ** | **2007** | ** ** | **2008** | ** ** |
| RiskMetrics business percent non-recurring revenue |       | 2.4                                                  | %          | 1.6                                                 | %          | 2.7 | % | 1.4 | % |
| ISS business percent non-recurring revenue         |       | 9.3                                                  | %          | 7.9                                                 | %          | 12.6 | % | 11.6 | % |

 

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***Our Operating Costs and Expenses***

 

Compensation expense represents a substantial majority of our expensesacross all of our operating functions. Compensation expenses before stock-basedcompensation expense are comprised of base salary, bonuses, benefits, payrolltaxes and sales commissions. While we expect to grow our headcount over time totake advantage of our market opportunity, we believe that the economies ofscale in our operating model will allow us to grow our compensation expenses ata lower rate than revenues.

 

Other meaningful operating expenses are data, proxy voting fees, occupancyand telecommunications and web hosting costs. Since we deliver our products andservices using a common data and technology infrastructure, we expect theseexpenses to generally increase at less than the rate of revenue growth.Overall, our goal is to keep the rate of growth of these operating expensesbelow the rate of growth of our revenues. However, in order to take advantageof growth opportunities, we may invest in our business in order to supportincreased revenue growth. This might result in variability in our operatingmargin in the short term.

 

We allocate compensation expenses, including stock-based compensationexpense, to our cost of revenues, sales and marketing, research and developmentand general and administrative expense categories based on the actual costsassociated with each employee. Other costs associated with the employees, suchas occupancy, travel and telecommunications, are included in the same costcategories as the corresponding employees. We allocate corporate and other sharedservices to each segment based on usage or headcount. The following summarizesour significant operating expenses:

 

*Costs of Revenues*

 

Costs of revenues include costs related to production of proxy researchand voting, web hosting, data, account management, implementation and systemsoperations and allowances for doubtful accounts. Costs in this area consistprimarily of staff compensation and related costs and payments to third partyvendors, including third party web hosting and data providers.

 

*Research and Development*

 

Research and development expenses include costs related to productdevelopment, research technology, application design, technology infrastructureand analytics development. Costs in this area consist primarily of staffcompensation costs and related expenses and consultant expenses.

 

*Selling and Marketing*

 

Selling and marketing expenses consist of costs related to our salesforce, product management and marketing professionals. These costs includestaff compensation costs and related expenses, including commissions andgeneral marketing costs.

 

*General and Administrative*

 

General and administrative expenses consist of expenses for finance,legal, accounting, human resources and information technology personnel. Costsin this area primarily consist of staff compensation and related expenses,legal costs, insurance costs, accounting fees and other professional servicesfees.

 

*Depreciation and Amortization of Property andEquipment*

 

Depreciation and amortization of property and equipment includesdepreciation of software, computer and related equipment, furniture andfixtures and telecommunications equipment, which is recorded over therespective useful lives of the related assets. Depreciation also includes theamortization of leasehold improvements which are amortized over the shorter ofthe term of the lease or the assets’ useful life, and the amortization ofcapitalized software costs. While both leasehold improvements and capitalizedsoftware costs are amortized, they are included in the depreciation line itemin order to segregate amortization of acquired intangibles.

 

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*Amortization of Intangible Assets*

 

Amortization expense includes the amortization of finite lifeintangible assets such as technology, contracts, customer relationships, tradenames, license agreements, proprietary process and non-compete agreementsacquired, which are amortized over their estimated useful lives.

 

***Adjusted EBITDA***

 

The Adjusted EBITDA data below sets forth supplementary informationthat we believe is useful for investors in evaluating our underlyingoperations:

 
| ** **      | ** ** | **Three months ended** | ** ** | ** **                 | ** ** | **Nine months ended** | ** ** | ** **                 | ** ** |
|-----------------|------------|----------------------------------|------------|----------------------------|------------|---------------------------------|------------|----------------------------|------------|
| ** **      | ** ** | **September 30,**           | ** ** | **% Growth for** | ** ** | **September 30,**          | ** ** | **% Growth for** | ** ** |
| ** **      | ** ** | **2007**                         | ** ** | **2008**                   | ** ** | **three months**           | ** ** | **2007**                   | ** ** | **2008** | ** ** | **nine months** | ** ** |
|            |       |                             |       |                       |       |                            |       |                       |       |   |   |   |   |
| Adjusted EBITDA |       | $                                | 18,444     |                       | $          | 25,040                          |       | 35.8                       | %          | $ | 51,329 |   | $ | 71,986 |   | 40.2 | % |
|                 |            |                                  |            |                            |            |                                 |            |                            |            |  |  |  |  |  |  |  |  |

 

Adjusted EBITDAfor the nine months ended September 30, 2007 does not include $0.9 milliongenerated from ISS from January 1 through January 11, 2007 as ISS wasacquired on January 11, 2007.  In addition, Adjusted EBITDA growthwas favorably impacted by the acquisition of CFRA on August 1, 2007.

 

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

 

We also presentAdjusted EBITDA as a supplemental performance measure because we believe thatthis measure provides our board of directors, management and investors withadditional information to measure our performance, provide comparisons fromperiod to period by excluding potential differences caused by variations incapital structure (affecting interest expense), tax position (such as the impacton periods of changes in effective tax rates or net operating losses), the ageand book depreciation of fixed assets (affecting relative depreciationexpense), acquisitions (affecting amortization expense) and compensation plans(affecting stock-based compensation expense).

 

Adjusted EBITDA isnot a measurement of our financial performance under U.S. GAAP and shouldnot be considered as an alternative to net income, operating income or anyother performance measures derived in accordance with U.S. GAAP or as analternative to cash flow from operating activities as a measure of ourprofitability or liquidity.

 

We understandthat, although Adjusted EBITDA is frequently used by securities analysts,lenders and others in their evaluation of companies, Adjusted EBITDA haslimitations as an analytical tool, and you should not consider it in isolation,or as a substitute for an analysis of our results as reported underU.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 include stock basedcompensation expense;

 

·                                          Adjusted EBITDA does not reflect changesin, 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;

 

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·                                          Although depreciation and amortizationare non-cash charges, the assets being depreciated and amortized often willhave to be replaced in the future, and Adjusted EBITDA does not reflect anycash requirements for such replacements; and

 

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

 

The table below sets forth a reconciliation of netincome to Adjusted EBITDA on our historical results:

 
| ** **                                              | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                              | ** ** | **2007**                                             | ** ** | **2008**                                            | ** ** | **2007** | ** ** | **2008** | ** ** |
| Net income                                              |       | $                                                    | 453        |                                                | $          | 6,282 |   | $ | 1,198 |   | $ | 12,175 |   |
| Interest, other income (expense), net                   |       | 9,359                                                |       | 4,860                                               |       | 26,198 |   | 21,337 |   |
| Income tax expense                                      |       | 244                                                  |       | 4,045                                               |       | 1,056 |   | 7,828 |   |
| Depreciation and amortization of property and equipment |       | 1,869                                                |       | 2,153                                               |       | 5,192 |   | 6,433 |   |
| Amortization of intangible assets                       |       | 5,105                                                |       | 5,398                                               |       | 13,728 |   | 16,310 |   |
| Stock-based compensation.                               |       | 1,414                                                |       | 2,245                                               |       | 3,955 |   | 7,622 |   |
| Non-recurring expenses (a)                              |       | —                                               |       | —                                              |       | — |   | 198 |   |
| Loss on disposal of property and equipment              |       | —                                               |       | 57                                                  |       | 2 |   | 83 |   |
| Adjusted EBITDA                                         |       | $                                                    | 18,444     |                                                | $          | 25,040 |   | $ | 51,329 |   | $ | 71,986 |   |

 

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(a) Represents lease exit costs incurredfrom moving the London operations.

 

**Critical Accounting Policies and Estimates**

 

Ourcondensed consolidated financial statements are prepared in conformity with USGAAP. Our critical accounting policies, including the assumptions and judgmentsunderlying them, require the application of significant judgment in thepreparation of our financial statements, and as a result they are subject to agreater degree of uncertainty. In applying these policies, we use our judgmentto determine the appropriate assumptions to be used in calculating estimatesthat affect the reported amounts of assets, liabilities, revenues and expenses.Estimates and assumptions are based on historical experience and on variousother factors that are believed to be reasonable under the circumstances.Accordingly, actual results could differ from those estimates. Significantestimates and assumptions made by management include the deferral andrecognition of revenue, impairment of goodwill and intangible assets,stock-based compensation, gains or losses on derivative instruments, accountingfor income taxes and other matters that affect the condensed consolidatedfinancial statements and related disclosures.  There have been no changesto our significant accounting policies since December 31, 2007.

 

**Results of Operations**

 

We operate in two segments, “the RiskMetrics business” and the “ISSbusiness.” We have provided a discussion of our results of operations on aconsolidated basis and have also provided certain detailed discussions for eachof our segments.

 

*Factors Affecting the Comparability of Results*

 

The results of ISS are not included in our results of operations untilthe acquisition date of January 11, 2007. In addition, the financialresults of CFRA, which was acquired on August 1, 2007, have been includedin the results of our ISS business only since the date of its acquisition. CFRAsupplements the ISS business to support the Financial Research and Analysisproduct and services offerings.

 

InJanuary 2008, we completed an initial public offering of 16,100,000 sharesof common stock, which included 4,035,816 shares sold by selling stockholdersand 2,100,000 shares to cover over-allotments, which was exercised in full in January 2008.  We received net proceeds of $193.9 millionfrom the offering. We did not receive any proceeds from the sale of the sharesby the selling stockholders.  As such, weighted average common sharesoutstanding for the three and nine months ended September 30, 2008includes 12,100,000 additional shares sold in the initial public offering. In addition,immediately prior to the completion of our initial public offering we grantedeach of our full-time employees an option to acquire 500 shares of our commonstock, at an exercise price equal to the initial public offering price. Suchgrant resulted in 

 

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stock-basedcompensation of $207 and $1,807 being recorded for the three and nine monthsended September 30, 2008, respectively.

 

InJanuary 2008, we utilized a portion of proceeds from the initial publicoffering to prepay the entire outstanding indebtedness under the second lienloan, in the amount of $125.0 million. As a result of the prepayment weincurred $5.0 million in expenses during the nine months ended September 30,2008, which were comprised of a $1.25 million debt prepayment penalty fee,a $2.4 million write-off of debt issuance costs and a $1.4 million loss onan interest rate swap settlement. Such costs have been included in interest,dividend, investment and other income (expense), net in the statement of incomefor the nine months ended September 30, 2008.

 

*Three months ended September 30, 2007 comparedto the three months ended September 30, 2008*

 

Thefollowing tables provide information with respect to our consolidated andsegment operating results:

 

**Consolidated RiskMetrics Group, Inc.**

 
| ** **                                                     | ** ** | **Three months ended  September 30,**               | ** ** | **Increase (decrease)** | ** ** |
|----------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                     | ** ** | **2007**                                                           | ** ** | **2008**                     | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                                     | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Revenues                                                       |       | $                                                                  | 62,159     |                         | $          | 75,554 |   | $ | 13,395 |   | 21.5 | % |
| Operating costs and expenses:                                  |       |                                                               |       |                         |       |   |   |   |   |
| Cost of revenues                                               |       | 20,706                                                             |       | 23,507                       |       | 2,801 |   | 13.5 | % |
| Research and development                                       |       | 7,678                                                              |       | 11,248                       |       | 3,570 |   | 46.5 | % |
| Selling and marketing                                          |       | 8,873                                                              |       | 9,045                        |       | 172 |   | 1.9 | % |
| General and administrative                                     |       | 7,872                                                              |       | 8,959                        |       | 1,087 |   | 13.8 | % |
| Depreciation and amortization of property and equipment        |       | 1,869                                                              |       | 2,153                        |       | 284 |   | 15.2 | % |
| Amortization of intangible assets                              |       | 5,105                                                              |       | 5,398                        |       | 293 |   | 5.7 | % |
| Loss on disposal of fixed assets                               |       | —                                                             |       | 57                           |       | 57 |   | — | % |
| Total operating costs and expenses(1)                          |       | 52,103                                                             |       | 60,367                       |       | 8,264 |   | 15.9 | % |
| Income from operations                                         |       | 10,056                                                             |       | 15,187                       |       | 5,131 |   | 51.0 | % |
| Interest, dividend, investment and other income (expense), net |       | (9,359                                                             | )          | (4,860                       | )          | 4,499 |   | 48.1 | % |
| Income before provision for income taxes                       |       | 697                                                                |       | 10,327                       |       | 9,630 |   | * | % |
| Provision for income taxes                                     |       | 244                                                                |       | 4,045                        |       | 3,801 |   | * | % |
| Net income                                                     |       | $                                                                  | 453        |                         | $          | 6,282 |   | $ | 5,829 |   | * | % |

 

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*exceeds 100%

 

(1) Includesstock-based compensation expense of $1,414 and $2,245 for the three monthsended September 30, 2007 and 2008, respectively.

 

**RiskMetrics Business**

 
| ** **                                              | ** ** | **Three months ended  September 30,**               | ** ** | **Increase (decrease)** | ** ** |
|---------------------------------------------------------|------------|--------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                              | ** ** | **2007**                                                           | ** ** | **2008**                     | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                              | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Revenues                                                |       | $                                                                  | 30,968     |                         | $          | 40,846 |   | $ | 9,878 |   | 31.9 | % |
| Operating costs and expenses:                           |       |                                                               |       |                         |       |   |   |   |   |
| Cost of revenues                                        |       | 7,341                                                              |       | 10,148                       |       | 2,807 |   | 38.2 | % |
| Research and development                                |       | 5,957                                                              |       | 7,471                        |       | 1,514 |   | 25.4 | % |
| Selling and marketing                                   |       | 4,446                                                              |       | 4,738                        |       | 292 |   | 6.6 | % |
| General and administrative                              |       | 3,635                                                              |       | 5,081                        |       | 1,446 |   | 39.8 | % |
| Depreciation and amortization of property and equipment |       | 1,116                                                              |       | 1,152                        |       | 36 |   | 3.2 | % |
| Loss (gain) on disposal of fixed assets                 |       | —                                                             |       | —                       |       | — |   | 0.0 | % |
| Total operating costs and expenses(2)                   |       | 22,495                                                             |       | 28,590                       |       | 6,095 |   | 27.1 | % |
| Income from operations                                  |       | $                                                                  | 8,473      |                         | $          | 12,256 |   | $ | 3,783 |   | 44.6 | % |

 

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(2) Includesstock-based compensation expense of $750 and $980 for the three months ended September 30,2007 and 2008, respectively.

 

**ISS Business**

 
| ** **                                              | ** ** | **Three months ended  September 30,**               | ** ** | **Increase (decrease)** | ** ** |
|---------------------------------------------------------|------------|--------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                              | ** ** | **2007**                                                           | ** ** | **2008**                     | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                              | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Revenues                                                |       | $                                                                  | 31,191     |                         | $          | 34,708 |   | $ | 3,517 |   | 11.3 | % |
| Operating costs and expenses:                           |       |                                                               |       |                         |       |   |   |   |   |
| Cost of revenues                                        |       | 13,365                                                             |       | 13,359                       |       | (6 | ) | — | % |
| Research and development                                |       | 1,721                                                              |       | 3,777                        |       | 2,056 |   | 119.5 | % |
| Selling and marketing                                   |       | 4,427                                                              |       | 4,307                        |       | (120 | ) | (2.7 | )% |
| General and administrative                              |       | 4,237                                                              |       | 3,878                        |       | (359 | ) | (8.5 | )% |
| Depreciation and amortization of property and equipment |       | 753                                                                |       | 1,001                        |       | 248 |   | 32.9 | % |
| Amortization of intangible assets.                      |       | 5,105                                                              |       | 5,398                        |       | 293 |   | 5.7 | % |
| Loss on disposal of fixed assets                        |       | —                                                             |       | 57                           |       | 57 |   | — |   |
| Total operating costs and expenses(3)                   |       | 29,608                                                             |       | 31,777                       |       | 2,169 |   | 7.3 | % |
| Income from operations                                  |       | $                                                                  | 1,583      |                         | $          | 2,931 |   | $ | 1,348 |   | 85.2 | % |

 

(3) Includesstock-based compensation expense of $664 and $1,265 the three months ended September 30,2007 and 2008, respectively.

 

Thefollowing tables provide information with respect to our consolidated andsegment revenues in certain geographic regions:

 

**Consolidated RiskMetrics Group, Inc.**

 
| ** **                            | ** ** | **Three months ended  September 30, 2007**     | ** ** | **Three months ended  September 30, 2008** | ** ** | **Increase (decrease)** | ** ** |
|---------------------------------------|------------|--------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|------------------------------|------------|
| **Region**                            | ** ** | **Revenue**                                                        | ** ** | **% of  Total  Revenue**                                  | ** ** | **Revenue**                  | ** ** | **% of  Total  Revenue** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                            | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Americas                              |       | $                                                                  | 38,503     |                                                           | 62.0       | %                            | $          | 45,648 |   | 60.4 | % | $ | 7,145 |   | 18.6 | % |
| Europe, Middle East and Africa (EMEA) |       | 19,291                                                             |       | 31.0                                                           | %          | 25,615                       |       | 33.9 | % | 6,324 |   | 32.8 | % |
| Asia                                  |       | 4,365                                                              |       | 7.0                                                            | %          | 4,291                        |       | 5.7 | % | (74 | ) | (1.7 | )% |
| Total                                 |       | $                                                                  | 62,159     |                                                           | 100.0      | %                            | $          | 75,554 |   | 100.0 | % | $ | 13,395 |   | 21.5 | % |

 

**RiskMetrics Business**

 
| ** **                            | ** ** | **Three months ended  September 30, 2007**     | ** ** | **Three months ended  September 30, 2008** | ** ** | **Increase (decrease)** | ** ** |
|---------------------------------------|------------|--------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|------------------------------|------------|
| **Region**                            | ** ** | **Revenue**                                                        | ** ** | **% of  Total  Revenue**                                  | ** ** | **Revenue**                  | ** ** | **% of  Total  Revenue** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                            | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Americas                              |       | $                                                                  | 14,812     |                                                           | 47.8       | %                            | $          | 18,776 |   | 46.0 | % | $ | 3,964 |   | 26.8 | % |
| Europe, Middle East and Africa (EMEA) |       | 13,491                                                             |       | 43.6                                                           | %          | 19,309                       |       | 47.3 | % | 5,818 |   | 43.1 | % |
| Asia                                  |       | 2,665                                                              |       | 8.6                                                            | %          | 2,761                        |       | 6.7 | % | 96 |   | 3.6 | % |
| Total                                 |       | $                                                                  | 30,968     |                                                           | 100.0      | %                            | $          | 40,846 |   | 100.0 | % | $ | 9,878 |   | 31.9 | % |

 

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**ISS Business**

 
| ** **                            | ** ** | **Three months ended  September 30, 2007**     | ** ** | **Three months ended  September 30, 2008** | ** ** | **Increase (decrease)** | ** ** |
|---------------------------------------|------------|--------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|------------------------------|------------|
| ** **                            | ** ** | ** **                                                         | ** ** | **% of Total**                                       | ** ** | ** **                   | ** ** | **% of Total** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Region**                            | ** ** | **Revenue**                                                        | ** ** | **Revenue**                                                    | ** ** | **Revenue**                  | ** ** | **Revenue** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                            | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Americas                              |       | $                                                                  | 23,691     |                                                           | 76.0       | %                            | $          | 26,872 |   | 77.4 | % | $ | 3,181 |   | 13.4 | % |
| Europe, Middle East and Africa (EMEA) |       | 5,800                                                              |       | 18.6                                                           | %          | 6,306                        |       | 18.2 | % | 506 |   | 8.7 | % |
| Asia                                  |       | 1,700                                                              |       | 5.4                                                            | %          | 1,530                        |       | 4.4 | % | (170 | ) | (10.0 | )% |
| Total                                 |       | $                                                                  | 31,191     |                                                           | 100.0      | %                            | $          | 34,708 |   | 100.0 | % | $ | 3,517 |   | 11.3 | % |

 

Set forth below is a discussion of our results for the three monthsended September 30, 2007 compared to the three months ended September 30,2008.

 

*Revenues.*Consolidated revenues increased from $62.2 million for thethree months ended September 30, 2007 to $75.6 million for the threemonths ended September 30, 2008, or 21.5 %. Revenue growth was driven by a 31.9% increase in the RiskMetrics businessand 11.3%increase in the ISS business.

 

RiskMetrics revenues increased from $31.0 million for the threemonths ended September 30, 2007 to $40.8 million for the three monthsended September 30, 2008, or 31.9%. The $9.9 million increase in revenueswas primarily due to a $8.7 million, or 32.4%, increase in revenues from ourMarket Risk products and services.  Theincrease in revenues from Market Risk Products was due to a 36.3% increase inrevenues from RiskManager due to strong sales of RiskManager to asset managersand hedge funds as they increased their outsourcing of risk reporting services.Increased revenues resulted from both increased sales to existing customers andsales to new customers. As a percentage of total revenues, revenues from ourMarket Risk products and services increased from 86.7% for the three monthsended September 30, 2007 to 87.0% for the three months ended September 30,2008.  Revenue growth was also driven bya 26.8% increase in the Americas region and a 43.1% increase in the EMEA regiondriven by strong sales of RiskManager in these regions due to, among otherthings, increased investor demand and the need for financial services firms tocomply with regulatory requirements.

 

ISS revenues increased $3.5million from $31.2 million for the three months ended September 30, 2007to $34.7 million for the three months ended September 30, 2008, or 11.3%.The increase in revenues was partially due to an increase in revenue from ourFinancial Research and Analysis products and services which increased from $9.2million to $11.1 million due to revenue growth of Corporate Advisory Servicesand M&A Edge products and a $1.2 million increase in CFRA revenue due tothe inclusion of three months of CFRA revenue in 2008 as CFRA was acquired on August 1,2007. The revenues from our Governance Services products increased 7.3% from$22.0 million to $23.6 million due to increased revenue in proxy research andvoting services. Governance Services revenue accounted for 68.1% of total ISSrevenue for the three months ended September 30, 2008 compared to 70.6% inthe prior year.

 

*Operatingcosts and expenses.*  Consolidated operating expenses increasedfrom $52.1 millionfor the three months ended September 30, 2007 to $60.4million for the three months ended September 30,2008, or 15.9%. Theincrease in operating expenses was due to the acquisition of CFRA, increases incompensation costs, including stock-based compensation, occupancy, data,hosting, foreign currency transaction expenses and increased travel.  As a percentage of revenue, operatingexpenses decreased from 83.8% to 79.9% due to increased economies of scale.

 

RiskMetrics operating expenses increased from $22.5 million for thethree months ended September 30, 2007 to $28.6 million for the threemonths ended September 30, 2008, or 27.1%. The increase was mainly due toincreased compensation costs of $3.0 million related to higher headcount, bonusaccrual and commission increases, as well as increased data, hosting, traveland $1.0 million of foreign currency transaction expenses.  As a percentage of revenues, operatingexpenses decreased from 72.6% to 70.0% due to increased economies of scale.

 

ISS operating expenses increasedfrom $29.6 million for the three months ended September 30, 2007 to $31.8million for the three months ended September 30, 2008, or 7.3%. Theincrease in operating expenses was primarily due to increased compensationcosts of $0.5 million (including CFRA), increased stock-based compensation of$0.6 million, additional operating expenses from CFRA, increased amortizationexpense of $0.3 million, as well as increased travel costs.  As a percentage of revenues, operating costsand expenses decreased from 94.9% to 91.6% due to increased economies of scale.

 

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*Cost of revenues.*  Consolidated cost of revenues increased from$20.7 million for the three months ended September 30, 2007 to $23.5million for the three months ended September 30, 2008, or 13.5%. As apercentage of revenues, cost of revenues decreased from 33.3% to 31.1%.

 

RiskMetrics cost of revenues increased from $7.3 million for the threemonths ended September 30, 2007 to $10.1 million for the three months endedSeptember 30, 2008, or 38.2%. The increase was primarily due to increasedcompensation costs, increased foreign currency transaction costs of $1.0million and an increase in third-party data costs of $0.5 million due to theincreased breadth of product offerings. As a percentage of revenues, cost of revenues increased from 23.7% to24.8% due to fluctuations in foreign currency rates.

 

ISS cost of revenues remainedconstant at $13.4 million for the three months ended September 30, 2007and 2008.  As a percentage of revenues,cost of revenues decreased from 42.8% to 38.5%.

 

*Research and development expenses.*  Consolidated research and developmentexpenses increased from $7.7 million for the three months ended September 30,2007 to $11.2 million for the three months ended September 30, 2008, or46.5%. As a percentage of revenues, research and development expenses increasedfrom 12.4% to 14.9% primarily due to increased compensation costs and increasedinvestment in research and development related to Governance Services productsand platforms.

 

RiskMetrics research and development expenses increased from $6.0million for the three months ended September 30, 2007 to $7.5 million forthe three months ended September 30, 2008, or 25.4%. The increase wasprimarily due to increased employee compensation costs due to an increasedfocus on market risk product development.

 

ISS research and developmentexpenses increased from $1.7 million for the three months ended September 30,2007 to $3.8 million for the three months ended September 30, 2008, or119.5%. The increase was primarily due to increased compensation costs, CFRAcosts and investment in research and development related to governance serviceproducts and platforms.

 

*Selling and marketing expenses.*  Consolidated selling and marketing expensesincreased from $8.9 million for the three months ended September 30, 2007to $9.0 million for the three months ended September 30, 2008, or 1.9%. Asa percentage of revenues, selling and marketing expenses decreased from 14.3%to 12.0% due to the synergies achieved from the integration of the Company’sglobal sales force and lower marketing expenses as a percentage of revenues.

 

RiskMetrics selling and marketing expenses increased from $4.4 millionfor the three months ended September 30, 2007 to $ 4.7 million for thethree months ended September 30, 2008, or 6.6%. The increase was primarilydue to increased commissions as a result of the increase in sales.

 

ISS selling and marketingexpenses decreased from $4.4 million for the three months ended September 30,2007 to $4.3 million for the three months ended September 30, 2008.  ISS selling and marketing expenses wereimpacted by the inclusion of CFRA costs in 2008, and benefits from theintegration of the global sale force.

 

*General and administrative expenses.*  Consolidated general and administrativeexpenses increased from $7.9 million for the three months ended September 30,2007 to $9.0 million for the three months ended September 30, 2008, or13.8%. The increase was primarily due to increased compensation, accounting,consulting and insurance costs as a result of being a public company as well asincreased occupancy costs.  As apercentage of revenues, general and administrative expenses decreased from12.7% to 11.9%.

 

RiskMetrics general and administrative expenses increased from $3.6million for the three months ended September 30, 2007 to $5.1 million forthe three months ended September 30, 2008, or 39.8%. The increase wasprimarily due to increased employee compensation due to increased headcount aswell as increased accounting, insurance and consulting costs.

 

ISS general and administrativeexpenses decreased from $4.2 million for the three months ended September 30,2007 to $3.9 million for the three months ended September 30, 2008, or8.5%. The decrease was primarily due to a decline in compensation costs as aresult of decreased headcount in this business.

 

*Depreciation and amortization of property andequipment.*  Depreciationand amortization of property and equipment increased from $1.9 million for thethree months ended September 30, 2007 to $2.2 million for the three monthsended September 30, 2008. The increase was primarily due to an increase incapital expenditures for leasehold improvements and computers to support theCompany’s increased headcount and facilities expansion.

 

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*Amortization of intangible assets.*  Amortization of intangible assets increasedfrom $5.1 million for the three months ended September 30, 2007 to $5.4million for the three months ended September 30, 2008 primarily from ouracquisition of CFRA on August 1, 2007 and purchase of an intangible asset.

 

*Interest, dividend and investment income (expense),net.*  Net interest, dividend andinvestment expense decreased from $9.4 million for the three months ended September 30,2007 to $4.9 million for the three months ended September 30, 2008. In January 2008,we utilized a portion of proceeds from the initial public offering to prepaythe entire outstanding indebtedness under the second lien loan, in the amountof $125.0 million. As a result of the IPO and debt prepayment, interest expensedecreased and interest income increased as a result of reduced debt borrowingsand increased cash balances during 2008.

 

*Provision for income taxes.*  The provision for income taxes represents aneffective tax rate of 39.2% for the three months ended September 30, 2008as compared to an effective rate of 35.0% for the comparable prior year period.The effective rate increased mainly due to increased provisions for uncertaintax positions related to prior years. Effective tax rates are subject to changebased on the taxable income in all the jurisdictions in which we do business.

 

*Nine months ended September 30, 2007 compared tothe nine months ended September 30, 2008*

 

Thefollowing tables provide information with respect to our consolidated andsegment operating results:

 

**Consolidated RiskMetrics Group, Inc.**

 
| ** **                                                     | ** ** | **Nine months ended  September 30,**                | ** ** | **Increase (decrease)** | ** ** |
|----------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                     | ** ** | **2007**                                                           | ** ** | **2008**                     | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                                     | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Revenues                                                       |       | $                                                                  | 172,674    |                         | $          | 220,900 |   | $ | 48,226 |   | 27.9 | % |
| Operating costs and expenses:                                  |       |                                                               |       |                         |       |   |   |   |   |
| Cost of revenues                                               |       | 56,667                                                             |       | 69,387                       |       | 12,720 |   | 22.4 | % |
| Research and development                                       |       | 22,477                                                             |       | 32,114                       |       | 9,637 |   | 42.9 | % |
| Selling and marketing                                          |       | 25,328                                                             |       | 27,531                       |       | 2,203 |   | 8.7 | % |
| General and administrative                                     |       | 20,828                                                             |       | 27,702                       |       | 6,874 |   | 33.0 | % |
| Depreciation and amortization of property and equipment        |       | 5,192                                                              |       | 6,433                        |       | 1,241 |   | 23.9 | % |
| Amortization of intangible assets                              |       | 13,728                                                             |       | 16,310                       |       | 2,582 |   | 18.8 | % |
| Loss on disposal of fixed assets                               |       | 2                                                                  |       | 83                           |       | 81 |   | * | % |
| Total operating costs and expenses(1)                          |       | 144,222                                                            |       | 179,560                      |       | 35,338 |   | 24.5 | % |
| Income from operations                                         |       | 28,452                                                             |       | 41,340                       |       | 12,888 |   | 45.3 | % |
| Interest, dividend, investment and other income (expense), net |       | (26,198                                                            | )          | (21,337                      | )          | 4,861 |   | (18.6 | )% |
| Income before provision for income taxes                       |       | 2,254                                                              |       | 20,003                       |       | 17,749 |   | * | % |
| Provision for income taxes                                     |       | 1,056                                                              |       | 7,828                        |       | 6,772 |   | * | % |
| Net income                                                     |       | $                                                                  | 1,198      |                         | $          | 12,175 |   | $ | 10,977 |   | * | % |

 

----

*exceeds 100%

(1) Includesstock-based compensation expense of $3,955 and $7,622 for the nine months endedSeptember 30, 2007 and 2008, respectively.

 

**RiskMetrics Business**

 
| ** **                                              | ** ** | **Nine months ended  September 30,**                | ** ** | **Increase (decrease)** | ** ** |
|---------------------------------------------------------|------------|--------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                              | ** ** | **2007**                                                           | ** ** | **2008**                     | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                              | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Revenues                                                |       | $                                                                  | 87,704     |                         | $          | 114,110 |   | $ | 26,406 |   | 30.1 | % |
| Operating costs and expenses:                           |       |                                                               |       |                         |       |   |   |   |   |
| Cost of revenues                                        |       | 22,220                                                             |       | 26,928                       |       | 4,708 |   | 21.2 | % |
| Research and development                                |       | 17,701                                                             |       | 21,627                       |       | 3,926 |   | 22.2 | % |
| Selling and marketing                                   |       | 12,549                                                             |       | 14,091                       |       | 1,542 |   | 12.3 | % |
| General and administrative                              |       | 10,177                                                             |       | 14,321                       |       | 4,144 |   | 40.7 | % |
| Depreciation and amortization of property and equipment |       | 3,286                                                              |       | 3,496                        |       | 210 |   | 6.4 | % |
| Loss on disposal of fixed assets                        |       | 2                                                                  |       | —                       |       | (2 | ) | — | % |
| Total operating costs and expenses(2)                   |       | 65,935                                                             |       | 80,463                       |       | 14,528 |   | 22.0 | % |
| Income from operations                                  |       | $                                                                  | 21,769     |                         | $          | 33,647 |   | $ | 11,878 |   | 54.6 | % |

 

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(2) Includesstock-based compensation expense of $2,368 and $3,106 for the nine months endedSeptember 30, 2007 and 2008, respectively.

 

**ISS Business**

 
| ** **                                              | ** ** | **Nine months ended  September 30,**                | ** ** | **Increase (decrease)** | ** ** |
|---------------------------------------------------------|------------|--------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                              | ** ** | **2007**                                                           | ** ** | **2008**                     | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                              | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Revenues                                                |       | $                                                                  | 84,970     |                         | $          | 106,790 |   | $ | 21,820 |   | 25.7 | % |
| Operating costs and expenses:                           |       |                                                               |       |                         |       |   |   |   |   |
| Cost of revenues                                        |       | 34,447                                                             |       | 42,459                       |       | 8,012 |   | 23.3 | % |
| Research and development                                |       | 4,776                                                              |       | 10,487                       |       | 5,711 |   | 119.6 | % |
| Selling and marketing                                   |       | 12,779                                                             |       | 13,440                       |       | 661 |   | 5.2 | % |
| General and administrative                              |       | 10,651                                                             |       | 13,381                       |       | 2,730 |   | 25.6 | % |
| Depreciation and amortization of property and equipment |       | 1,906                                                              |       | 2,937                        |       | 1,031 |   | 54.1 | % |
| Amortization of intangible assets                       |       | 13,728                                                             |       | 16,310                       |       | 2,582 |   | 18.8 | % |
| Loss on disposal of fixed assets                        |       | —                                                             |       | 83                           |       | 83 |   | — |   |
| Total operating costs and expenses(3)                   |       | 78,287                                                             |       | 99,097                       |       | 20,810 |   | 26.6 | % |
| Income from operations                                  |       | $                                                                  | 6,683      |                         | $          | 7,693 |   | 1,010 |   | 15.1 | % |
|                                                         |            |                                                                    |            |                              |            |  |  |  |  |  |  |  |

 

(3) Includesstock-based compensation expense of $1,587 and $4,516 for the nine months endedSeptember 30, 2007 and 2008, respectively.

 

Thefollowing table provides information with respect to our consolidated andsegment revenues in certain geographic regions:

 

**Consolidated RiskMetrics Group, Inc.**

 
| ** **                            | ** ** | **Nine months ended  September 30, 2007**      | ** ** | **Nine months ended  September 30, 2008** | ** ** | ** **  | ** ** | ** **    | ** ** |
|---------------------------------------|------------|--------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|-------------|------------|---------------|------------|
| ** **                            | ** ** | ** **                                                         | ** ** | **% of**                                                 | ** ** | ** **  | ** ** | **% of** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                            | ** ** | ** **                                                         | ** ** | **Total**                                                     | ** ** | ** **  | ** ** | **Total**     | ** ** | **Increase (decrease)** | ** ** |
| **Region**                            | ** ** | **Revenue**                                                        | ** ** | **Revenue**                                                   | ** ** | **Revenue** | ** ** | **Revenue**   | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                            | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Americas                              |       | $                                                                  | 108,374    |                                                          | 62.8       | %           | $          | 135,887       |       | 61.5 | % | $ | 27,513 |   | 25.4 | % |
| Europe, Middle East and Africa (EMEA) |       | 52,700                                                             |       | 30.5                                                          | %          | 72,179      |       | 32.7          | %          | 19,479 |   | 37.0 | % |
| Asia                                  |       | 11,600                                                             |       | 6.7                                                           | %          | 12,834      |       | 5.8           | %          | 1,234 |   | 10.6 | % |
| Total                                 |       | $                                                                  | 172,674    |                                                          | 100.0      | %           | $          | 220,900       |       | 100.0 | % | $ | 48,226 |   | 27.9 | % |

 

**RiskMetrics Business**

 
| ** **                            | ** ** | **Nine months ended  September 30, 2007**      | ** ** | **Nine months ended  September 30, 2008** | ** ** | ** **  | ** ** | ** **    | ** ** |
|---------------------------------------|------------|--------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|-------------|------------|---------------|------------|
| ** **                            | ** ** | ** **                                                         | ** ** | **% of**                                                 | ** ** | ** **  | ** ** | **% of** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                            | ** ** | ** **                                                         | ** ** | **Total**                                                     | ** ** | ** **  | ** ** | **Total**     | ** ** | **Increase (decrease)** | ** ** |
| **Region**                            | ** ** | **Revenue**                                                        | ** ** | **Revenue**                                                   | ** ** | **Revenue** | ** ** | **Revenue**   | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                            | ** ** | **(Amounts in thousands, except percentages)** | ** ** |
| Americas                              |       | $                                                                  | 42,104     |                                                          | 48.0       | %           | $          | 52,203        |       | 45.7 | % | $ | 10,099 |   | 24.0 | % |
| Europe, Middle East and Africa (EMEA) |       | 38,200                                                             |       | 43.6                                                          | %          | 53,800      |       | 47.1          | %          | 15,600 |   | 40.8 | % |
| Asia                                  |       | 7,400                                                              |       | 8.4                                                           | %          | 8,107       |       | 7.2           | %          | 707 |   | 9.6 | % |
| Total                                 |       | $                                                                  | 87,704     |                                                          | 100.0      | %           | $          | 114,110       |       | 100.0 | % | $ | 26,406 |   | 30.1 | % |

 

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**ISS Business**

 
| ** **                            | ** ** | **January 12, 2007  to September 30, 2007** | ** ** | **Nine months ended  September 30, 2008** | ** ** | ** **  | ** ** | ** **               | ** ** |
|---------------------------------------|------------|----------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|-------------|------------|--------------------------|------------|
| ** **                            | ** ** | ** **                                                           | ** ** | **% of Total**                                      | ** ** | ** **  | ** ** | **% of Total** | ** ** | **Increase (decrease)** | ** ** |
| **Region**                            | ** ** | **Revenue**                                                          | ** ** | **Revenue**                                                   | ** ** | **Revenue** | ** ** | **Revenue**              | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                            | ** ** | **(Amounts in thousands, except percentages)**   | ** ** |
| Americas                              |       | $                                                                    | 66,270     |                                                          | 78.0       | %           | $          | 83,684                   |       | 78.4 | % | $ | 17,414 |   | 26.3 | % |
| Europe, Middle East and Africa (EMEA) |       | 14,500                                                               |       | 17.1                                                          | %          | 18,379      |       | 17.2                     | %          | 3,879 |   | 26.8 | % |
| Asia                                  |       | 4,200                                                                |       | 4.9                                                           | %          | 4,727       |       | 4.4                      | %          | 527 |   | 12.5 | % |
| Total                                 |       | $                                                                    | 84,970     |                                                          | 100.0      | %           | $          | 106,790                  |       | 100.0 | % | $ | 21,820 |   | 25.7 | % |

 

Set forth below is a discussion of our results for the nine monthsended September 30, 2007 compared to the nine months ended September 30,2008.

 

*Revenues.*Consolidated revenues increased from $172.7 million for the ninemonths ended September 30, 2007 to $220.9 million for the nine monthsended September 30, 2008, or 27.9%. Revenue growth was driven by a 30.1% increase in the RiskMetrics businessand 25.7%increase in the ISS business. In addition, ISS revenue growth was impactedby a $9.9 million increase in CFRA revenue due to the inclusion of sevenadditional months of CFRA revenue in 2008, the inclusion of 11 additional days in the nine months endedSeptember 30, 2008 and organic revenue growth in the Governance Servicesand Financial Research and Analysis product lines.

 

RiskMetrics revenues increased from $87.7 million for the nine monthsended September 30, 2007 to $114.1 million for the nine months ended September 30,2008, or 30.1%. The $26.4 million increase in revenues was primarily due to a$24.9 million, or 33.2%, increase in revenues from our Market Riskproducts.  The increase in revenues fromMarket Risk Products was due to a 38.9% increase in revenues from RiskManagerdue to strong sales of RiskManager to asset managers and hedge funds as theyincreased their outsourcing of risk reporting services.  As a percentage of total revenues, revenuesfrom our Market Risk products and services increased from 85.6% for the ninemonths ended September 30, 2007 to 87.6% for the nine months ended September 30,2008.  Revenue growth was also driven bya 24.0% increase in the Americas region and a 40.8% increase in the EMEA regiondriven by strong sales of RiskManager in these regions due to, among otherthings, increased investor demand and the need for financial services firms tocomply with regulatory requirements.

 

ISS revenues increased from$85.0 million for the period from January 12, 2007 to September 30,2007 to $106.8 million for the nine months ended September 30, 2008, or25.7%. During the period from January 1 to January 11, 2007, ISSrecognized revenues of $3.3 million. Had these eleven days of revenue beenincluded in the nine months ended September 30, 2007, revenue would havebeen $88.3 million, an increase of 20.9% as compared to the nine months ended September 30,2008. All the information provided in the remainder of this paragraph reflectsthe inclusion of the revenues for this 11-day period. The increase in revenueswas primarily due to a $13.4 million increase in revenue from our FinancialResearch and Analysis products and services which increased from $24.0 millionto $37.4 million, or 55.8%, due to a $9.9 million increase in CFRA revenue,which was acquired on August 1, 2007, and growth from our Corporate andCompensation Advisory Services, ES&G and M&A Edge products. Revenuesfrom our Governance Services products increased 7.9% from $64.3 million to$69.4 million due to increased revenue in all proxy research and votingservices. Governance services revenue accounted for 65.0% of total revenue forthe nine months ended September 30, 2008 compared to 72.8% in the prioryear.

 

*Operatingcosts and expenses.*  Consolidating operating expenses increasedfrom $144.2 millionfor the nine months ended September 30, 2007 to $179.6 million for the nine months ended September 30,2008, or 24.5%. Theincrease in operating expenses was due to the acquisition of CFRA, increasedcompensation expense of $16.4 million, increased stock-based compensation of $3.7 million, including $1.8 million of IPO charges, as well asincreased amortization, travel, data, occupancy, foreign currency costs,accounting and consulting costs. As a percentage of revenue, operating expensesdecreased from 83.5% to 81.3% due to increased economies of scalepartially offset by increased amortization and stock-based compensationexpense.

 

RiskMetrics operating expenses increased from $65.9 million for thenine months ended September 30, 2007 to $80.5 million for the nine monthsended September 30, 2008, or 22.0 %. The increase was mainly due toincreased compensation costs of $6.7 million related to higher headcount, bonusaccrual and commission increases, as well as increased data, occupancy, foreigncurrency costs, and accounting insurance and consulting costs. As a percentageof revenues, operating expenses decreased from 75.2% to 70.5% due to increasedeconomies of scale.

 

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ISS operating expenses increasedfrom $78.3 million for the period from January 12, 2007 to September 30,2007 to $99.1 million for the nine months ended September 30, 2008, or26.6%. The increase in operating expenses was primarily due to increased compensationcosts of $9.7 million (including CFRA), operating expenses of CFRA, increasedamortization expense of $2.6 million, a $2.9 million increase in stock-basedcompensation expense, increased occupancy costs and the inclusion of 11additional days in the 2008 period. As a percentage of revenues, operatingcosts and expenses increased from 92.1% to 92.8% primarily due to increases instock-based compensation, amortization expense and investment in research anddevelopment related to governance service products and platforms.

 

*Cost of revenues.*  Consolidated cost of revenues increased from$56.7 million for the nine months ended September 30, 2007 to $69.4million for the nine months ended September 30, 2008, or 22.4%. As apercentage of revenues, cost of revenues decreased from 32.8% to 31.4%. Theincrease in cost of revenues resulted primarily from increased compensation,including stock-based compensation of $1.8 million, increased data costs andincreases at ISS as a result of CFRA costs which historically has a higher costof revenue, partially offset by increased margins in the RiskMetrics business.

 

RiskMetrics cost of revenues increased from $22.2 million for the ninemonths ended September 30, 2007 to $26.9 million for the nine months endedSeptember 30, 2008, or 21.2%. The increase was primarily due to increasedcompensation costs and a $1.2 million increase in third- party data costs dueto the increased breadth of product offerings. As a percentage of revenues, Risk cost of revenues decreased from 25.3%to 23.6% due to increased economics of scale.

 

ISS cost of revenues increasedfrom $34.4 million for the period from January 12, 2007 to September 30,2007 to $42.5 million for the nine months ended September 30, 2008, or23.3%. The increase was primarily due to CFRA costs, compensation costs, anincrease in stock-based and increased occupancy costs.  As a percentage of revenues, ISS cost ofrevenues decreased from 40.5% to 39.8%.

 

*Research and development expenses.*  Consolidated research and developmentexpenses increased from $22.5 million for the nine months ended September 30,2007 to $32.1 million for the nine months ended September 30, 2008, or42.9%. As a percentage of revenues, research and development expenses increasedfrom 13.0% to 14.5% primarily due to increased compensation costs, includingstock-based compensation and increased investment in research and developmentrelated to governance service products and platforms.

 

RiskMetrics research and development expenses increased from $17.7 millionfor the nine months ended September 30, 2007 to $21.6 million for the ninemonths ended September 30, 2008, or 22.2%. The increase was primarily dueto increased employee compensation costs related to the continued investment inmarket risk product development.

 

ISS research and developmentexpenses increased from $4.8 million for the period from January 12, 2007to September 30, 2007 to $10.5 million for the nine months ended September 30,2008, or 119.6%. The increase was primarily due to increased compensation costsan increase in stock-based compensation, CFRA costs and investment in researchand development related to governance service products and platforms.

 

*Selling and marketing expenses.*  Consolidated selling and marketing expensesincreased from $25.3 million for the nine months ended September 30, 2007to $27.5 million for the nine months ended September 30, 2008, or 8.7%. Asa percentage of revenues, selling and marketing expenses decreased from 14.7%to 12.5% due to synergies achieved from the integration of the Company’s globalsales force and lower marketing expenses as a percentage of revenues.

 

RiskMetrics selling and marketing expenses increased from$12.5 million for the nine months ended September 30, 2007 to $14.1million for the nine months ended September 30, 2008, or 12.3%. Theincrease was primarily due to increased commissions as a result of the increasein sales.

 

ISS selling and marketingexpenses increased from $12.8 million for the period from January 12, 2007to September 30, 2007 to $13.4 million for the nine months ended September 30,2008, or 5.2%. The increase was primarily due to the inclusion of CFRA costs in2008, increased compensation, and stock-based compensation.

 

*General and administrative expenses.*  Consolidated general and administrativeexpenses increased from $20.8 million for the nine months ended September 30,2007 to $27.7 million for the nine months ended September 30, 2008, or33.0%. As a percentage of revenues, general and administrative expenses increasedfrom 12.1% to 12.5% due to increased occupancy costs, increased compensationcosts and accounting, insurance and consulting costs as a result of being apublic company.

 

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RiskMetrics general and administrative expenses increased from $10.2million for the nine months ended September 30, 2007 to $14.3 million forthe nine months ended September 30, 2008, or 40.7%. The increase wasprimarily due to an increase in occupancy costs, employee compensation andaccounting, insurance and consulting costs as a result of being a publiccompany.

 

ISS general and administrativeexpenses increased from $10.7 million for the period from January 12, 2007to September 30, 2007 to $13.4 million for the nine months ended September 30,2008, or 25.6%. The increase was primarily due to increased compensation andincreased stock-based compensation expenses and CFRA costs.

 

*Depreciation and amortization of property andequipment.*  Depreciationand amortization of property and equipment increased from $5.2 million for thenine months ended September 30, 2007 to $6.4 million for the nine monthsended September 30, 2008. The increase was primarily due to an increase incapital expenditures for leasehold improvements and computers to support theCompany’s increased headcount and facilities expansion.

 

*Amortization of intangible assets.*  Amortization of intangible assets increasedfrom $13.7 million for the nine months ended September 30, 2007 to $16.3million for the nine months ended September 30, 2008 primarily from ouracquisition of CFRA on August 1, 2007 and purchase of an intangible assetin the fourth quarter of 2007.

 

*Interest, dividend and investment income (expense),net.*  Net interest, dividend andinvestment expense decreased from $26.2 million for the nine months ended September 30,2007 to $21.3 million for the nine months ended September 30, 2008.  This decrease in expense was due to decreasedinterest expense (net of amortization) and increased interest income as aresult of reduced debt borrowings and increased cash balances during 2008.  In January 2008, we utilized a portionof proceeds from the initial public offering to prepay the entire outstandingindebtedness under the second lien loan, in the amount of $125.0 million.As a result of the prepayment we incurred $5.0 million in expenses during thenine months ended September 30, 2008, which were comprised of a$1.25 million debt prepayment penalty fee, a $2.4 million write-off ofdebt issuance costs and a $1.4 million loss on an interest rate swapsettlement.

 

*Provision for income taxes.*  The provision for income taxes represents aneffective tax rate of 39.1% for the nine months ended September 30, 2008as compared to an effective rate of 46.8% for the comparable prior year period.The effective rate changed mainly due to a decrease in non-deductiblestock-based compensation expense and increased pre-tax income. Effective tax ratesare subject to change based on the taxable income in all the jurisdictions inwhich we do business.

 

**Liquidity and Capital Resources**

 

At September 30, 2008 and December 31, 2007, we had cash andcash equivalents of $151.7 million and $27.5 million, respectively.  In January 2008, we completed an initialpublic offering of our common stock.  Ournet proceeds from the offering, including the exercise of the underwriters’allotment, were $193.9 million, after deducting underwriting discounts andcommissions and approximately $3.5 million of offering expenses, of whichwe utilized $125.0 million to repay in full our second lien term loanfacility. We believe our existing cash and cash equivalents, our cash flow fromoperating activities and availability under our existing credit facilities willbe sufficient to meet our anticipated cash needs for at least the next12 months, during which time we expect to make approximately$11.0 million to $12.0 million of capital expenditures. Our future workingcapital requirements will depend on many factors, including our revenue growth,debt service, future acquisitions of businesses and investments in our ownbusiness. To the extent our liquidity sources are insufficient to fund ourfuture activities we may need to raise additional funding through a public orprivate equity or debt offering. No assurances can be given that additionalfinancing will be available in the future or that if available, such financingwill be on favorable terms.

 

*Cash Flows*

 

Our cash flow tends to be lower in the beginning of each year due tobonuses and commissions paid during this period. As a result, we typicallygenerate more cash flows from operations during the second half of the yearthan during the first half of the year.

 

Cash flows from operating activities increased by $41.5 million in thenine months ended September 30, 2008 compared to 2007 due to increased netincome and increased contribution from working capital.   Operatingactivities for the nine months ended September 30, 2008 provided cash of$58.8 million primarily reflectingnet income of $12.2 million plus stock-based compensation of $7.6 million,depreciation and amortization of $25.9 million, a $7.2 million increase inaccrued expenses, a $1.8 million net increase in deferred revenue and accountsreceivable and a $6.3 million net increase from taxes.  Cash flow fromoperations in 2008 was negatively impacted by $1.3 million of cash used for adebt pre-payment penalty fee 

 

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and $1.4 million for aninterest rate swap settlement in connection with the pre-payment of debt in2008.  Operating activities for the ninemonths ended September 30, 2007 provided cash of $17.3 million primarily reflecting net incomeof $1.2 millionplus depreciation and amortization of $20.0 million, plus stock-based compensation of$4.0 millionpartially offset by a $3.8 million decline in accrued expenses due to bonuspayments.

 

Investing activities for the nine months ended September 30, 2008used cash of $6.7 million, primarily due to capital expenditures of $5.8million and the purchase of an intangible asset. Investing activities for thenine months ended September 30, 2007 used cash of $463.3 million,primarily due to the acquisitions of ISS and CFRA, which included theliquidation of investments that provided us $68.1 million of cash, as well ascapital expenditures of $6.1 million.

 

Financing activities for the nine months ended September 30, 2008provided cash of $74.4 million as a result of $197.4 million raised from ourinitial public offering and $5.7 million from stock option proceeds, partiallyoffset by $132.1 million in debt payments. Financing activities for the ninemonths ended September 30, 2007 provided cash of $431.8 million as aresult of proceeds received from the incurrence of $440.0 million ofindebtedness in connection with the acquisitions of ISS and CFRA and $5.4million in stock option proceeds, partially offset by $10.1 million indebt issuance costs.

 

*Long Term Debt*

 

In connection with the purchase of ISS on January 11, 2007, weincurred $425.0 million of indebtedness. The indebtedness was comprised offirst lien and second lien term loans. We also entered into a first lienrevolving credit facility. The terms of the indebtedness include variouscovenant compliance requirements, including maintaining certain Adjusted EBITDAearning levels, as defined in our credit facilities. The Company has pledgedall of its assets as collateral against the debt. Amounts paid under the termloans may not be re-borrowed. The maturity dates of the first lien loan, secondlien loan and revolving credit facility loans are January 2013, January 2014and July 2014, respectively.

 

In February 2007, we entered into two interest-rate swapagreements to reduce interest rate risks and to manage interest expense. Byentering into these agreements, we change the fixed/variable interest-rate mixof our debt portfolio. As of September 30, 2008, the interest rate swapshad notional principle amounts of $279,938 and a fair value liability of$9,865. The agreements effectively convert our floating-rate debt intofixed-rate debt. This reduces our risk of incurring higher interest costs inperiods of rising interest rates and increases our risk of paying higherinterest costs in periods of decreasing interest rates. Our interest-rate swapagreements hedge a significant portion of the interest rate risk exposure underour indebtedness. The interest rate swap agreements increased our weightedaverage effective interest rate on the first lien term loan facility to 7.37%during the nine months ended September 30, 2008. The interest rate on theCompany’s debt was reduced by 25 basis points in April 2008 due to areduction in the Company’s consolidated debt-leverage ratio.  The variable benchmark interest rates onEurodollar based loans associated with these instruments ranged from 2.7% to4.8% during the nine months ended September 30, 2008.

 

In January 2008, we utilized a portion of proceeds from ourinitial public offering to prepay the entire outstanding indebtedness under oursecond lien term loan which amounted to $125.0 million. In addition, wepaid a 1% prepayment penalty fee, or $1.25 million, upon repayment as setforth in the credit agreement. In conjunction with the repayment of our secondloan lien, we wrote-off debt issuance costs of $2.4 million and reducedthe notional amount of our interest rate swap by $19.3 million whichresulted in additional expense of $1.4 million during the nine monthsended September 30, 2008. During the nine months ended September 30,2008, we paid an excess cash flow principal payment of $6.4 million for ourfirst lien term loan, as required by the credit facility. The next principaldebt payment of $0.7 million is due on June 30, 2009.

 

As of September 30, 2008, we were in compliance with our creditagreements, and we are not aware of any future events or transactions that willimpact such compliance.

 

*Commitments*

 

In addition to the indebtedness discussed above, we enter into routineoperating lease obligations for our facilities and purchase obligations tooperate our business. Our contractual commitments, including those related toour indebtedness, were comprised of the following as of September 30,2008:

 

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| ** **                            | ** ** | **Payments Due by Period** | ** ** |
|---------------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligation**       | ** ** | **Total**                                 | ** ** | **Within 1 year** | ** ** | **1-3 years** | ** ** | **4-5 years** | ** ** | **After 5 years** | ** ** |
| Debt, including estimated interest    |       | $                                         | 390,874    |   | $ | 21,953 |   | $ | 46,243 |   | $ | 45,403 |   | $ | 277,275 |   |
| Operating leases                      |       | 23,859                                    |       | 6,371 |   | 11,636 |   | 5,681 |   | 171 |   |
| Purchase obligation for data          |       | 9,904                                     |       | 7,163 |   | 2,741 |   | — |   | — |   |
| Deferred purchase price obligation(1) |       | 1,164                                     |       | 211 |   | 453 |   | 500 |   | — |   |
| Total (2)                             |       | $                                         | 425,801    |   | $ | 35,698 |   | $ | 61,073 |   | $ | 51,584 |   | $ | 277,446 |   |

 

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(1)                                  Obligationrelates to prior acquisitions made by ISS.

(2)                                  Does notinclude $1,757 of liabilities for uncertain tax liabilities.  The timing of future cash flows associatedwith our liabilities for uncertain tax positions is highly uncertain and we areunable to make reasonably reliable estimates of the period of cash settlementwith the respective taxing authorities.

 

*Off-Balance Sheet Arrangements*

 

We do not maintain any off-balance sheet arrangements, transactions,obligations or other relationships with unconsolidated entities that would beexpected to have a material current or future impact upon our financialcondition or results of operations.

 

*Impact of Inflation*

 

Our business may be significantly or adversely affected by inflation.Due to the high degree of competition in the marketplace, inflation rateincreases might lead to an erosion of our profit margins.

 

*RelatedParty Transaction*

 

In May 2008,we entered into a contract for the sale of Market Risk products to Duff CapitalAdvisors. Philip Duff, a director of the Company, is the founder, CEO andGeneral Partner of Duff Capital Advisors. The contract was entered into in thenormal course of business on terms that we believe are consistent with (and notpreferential to) those provided to our other clients. We recognized $252 and422 in revenue from the Duff Capital Advisors contract for the three and ninemonths ended September 30, 2008, respectively.

 

**Effects of Recently Issued Accounting Pronouncements**

 

InSeptember 2006, the FASB issued SFAS No. 157, *Fair Value Measurements*. SFAS 157defines fair value, establishes a framework for measuring fair value, andexpands disclosures about fair value measurements. In February 2008, the FASB issued FASB StaffPosition 157-2, *Effective Date of FASBStatement No. 157*, which provides a one year deferral of theeffective date of SFAS 157 for non-financial assets and liabilities (suchas goodwill), except those that are recognized or disclosed in the Company’sfinancial statements at fair value at least annually. Accordingly, we adoptedthe provisions of SFAS 157 only for its financial assets and liabilitiesrecognized or disclosed at fair value on a recurring basis effective January 1,2008. The Company’s financial assets measured at fair value on a recurringbasis consist of derivative instruments.  See Note 8 of the condensed consolidatedfinancial statements regarding the fair value measurement for the Company’sderivative instruments.

 

In February 2007, the FASB issued SFAS No. 159 (“SFAS 159”),*The Fair Value Option for Financial Assetsand Financial Liabilities*, providing companies with an option toreport selected financial assets and liabilities at fair value. SFAS 159’sobjective is to reduce both complexity in accounting for financial instrumentsand the volatility in earnings caused by measuring related assets andliabilities differently. US GAAP 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 companies to provideadditional information that will help investors and other users of financialstatements to more easily understand the effect of the Company’s choice to usefair value on its earnings. It also requires entities to display the fair valueof these assets and liabilities for which the Company has chosen to use fairvalue on the face of the balance sheet. The Company adopted SFAS 159 on January 1,2008 but did not elect the fair value option for any qualifying financialinstruments presented in the consolidated financial statements.

 

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On December 4, 2007, FASB issued Statement No. 141(R),*Business Combinations*(SFAS 141(R)) and Statement No. 160, *Accountingand Reporting of Noncontrolling Interests in Consolidated Financial Statements*,an amendment of ARB No. 51 (SFAS 160). These new standards willsignificantly change the financial accounting and reporting of businesscombination transactions and noncontrolling (or minority) interests in consolidatedfinancial statements. SFAS 141(R) is generally required to be adoptedconcurrently with Statement No. 160 and is effective for businesscombination transactions for which the acquisition date is on or after thebeginning of the first annual reporting period beginning on or after December 15,2008. Early adoption is prohibited. Application of SFAS 141(R) andSFAS 160 is required to be adopted prospectively, except for certainprovisions of SFAS 160, which are required to be adopted retrospectively.Business combination transactions accounted for before adoption ofSFAS 141(R) should be accounted for in accordance withSFAS141 141 and that accounting previously completed under Statement No. 141should not be modified as of or after the date of adoption of StatementNo.141(R). The impactof adopting SFAS 141R and SFAS 160 will be dependent on the businesscombinations that the Company may pursue after its effective date.

 

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

 

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

 

**Item 3. Quantitative andQualitative Disclosures About Market Risk**

 

Our primary market risk exposure is interest raterisk associated with short and long-term debt bearing variable interest rates.To manage this interest rate risk exposure, we enter into interest rate swapagreements. We are also exposed to foreign currency risk, which can adverselyaffect our sales and operating profits. The following discussion should be readin conjunction with Note 8 of our condensed consolidated financialstatements appearing elsewhere in this Form 10-Q, which provides furtherinformation on our derivative instruments.

 

*Interest Rate Sensitivity*

 

To reduce the exposure associated with our variablerate debt, we entered into two interest-rate swap agreements to reduce interestrate risks and to manage interest expense. By entering into these agreements,we change the fixed/variable interest-rate mix of our debt portfolio. As of September 30,2008, the interest rate swaps had notional amounts of $279,938 and a fair valueliability of $9,865. 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 interest rate swap agreements increased our weighted average effectiveinterest rate on the first lien term loan facility to 7.37% during the ninemonths ended September 30, 2008. A hypothetical, instantaneous increase ofone percentage point in the interest rates applicable to the variable interestrate debt would have increased our net interest expense for the nine monthsended September 30, 2008 by approximately $2,532.

 

*Exchange Rate Sensitivity*

 

We have two separate exposures to currencyfluctuation risk—subsidiaries outside the United States which use a foreigncurrency as their functional currency which are translated into U.S. dollarsfor consolidation of assets and liabilities and non-U.S. dollar invoicedrevenues. Changes in foreign exchange rates for our subsidiaries that use aforeign currency as their functional currency are translated into U.S. dollarsand result in cumulative translation adjustments, which are included inaccumulated other comprehensive loss. At September 30, 2008, we hadtranslation exposure to various foreign currencies including the Euro, PoundsSterling, Canadian Dollar, and a limited number of other non-U.S. dollarcurrencies. The net potential loss resulting from a hypothetical 10% adversechange in quoted foreign currency exchange rates partially offset by acorresponding appreciation of the US dollar, as of September 30, 2008,amounts to $2,160.

 

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

 

**Item 4. Controls andProcedures**

 

**(a)****          ****Evaluation of DisclosureControls and Procedures**

 

We carried out an evaluation, under the supervisionand with the participation of our management, including our chief executiveofficer and chief financial officer, of the design and operation of ourdisclosure controls and procedures (as such term is defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)as of September 30, 2008, pursuant to Exchange Act Rule 13a-15. Basedupon that evaluation, the chief executive officer and chief financial officerconcluded that the our disclosure controls and procedures as of September 30,2008 are effective for gathering, analyzing and disclosing the information theCompany is required to disclose in the reports it files under the Exchange Act,within the time periods specified in the Securities and Exchange Commission’s rules andforms.

 

**(b)****          ****Changes in Internal ControlsOver Financial Reporting**

 

There were no changes in our internal controls overfinancial reporting during our fiscal quarter ended September 30, 2008that have materially affected, or are reasonably likely to materially affect,our internal control over financial reporting.

 

**Part II**

 

**Item 1. Legal Proceedings**

 

We are not presently involved in any legalproceedings which we believe would have a material adverse effect on ourconsolidated financial statements. However, during the ordinary course ofbusiness, we are, from time to time, threatened with, or may become a party to,legal actions and other proceedings.

 

**Item 1A. Risk Factors**

 

With the exception of material changes to thefollowing previously disclosed risk factor, there have been no other materialchanges in our risk factors from those disclosed in Part 1, Item 1Aof our 2007 Form 10-K.

 

***Our revenues and earnings depend substantially upon conditionsin the financial services industry, and a significant or prolonged downturn inthe financial services industry could decrease demand for our products andservices.***

 

Our revenues areprincipally derived from the provision of risk management and corporategovernance products and services to the financial services industry.  The vast majority of our business involvesthe sale of products and services to clients in the financialservices industry including asset managers, banks, insurance companies, hedgefunds, pension funds as well as professional organizations that serve thefinancial services industry.  The global financial markets have beenadversely impacted by the current market environment thatincludes illiquidity, market volatility, widening credit spreads, changesin interest rates, currency exchange fluctuations and new legaland compliance requirements.  These market conditions andthe reduced business activity have had a negative impact on a numberof our clients and could negatively impact our future revenues due to thepotential for declining sales and renewal rates.

 

Similarly,we are exposed to other market trends in the financial services industry.Consolidation in the financial services industry could reduce our existingclient base and the number of potential clients. This may negatively impact ourability to generate future growth and may reduce demand for our products andservices, which could have a material adverse effect on our business, financialcondition or results of operations.

 

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

 

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

 

On January 25, 2008, we granted 1,563,500options to our employees immediately prior to the consummation of our initialpublic offering, 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.

 

On January 30, 2008, we completed our initialpublic offering of 16,100,000 shares of our common stock, which included4,035,816 shares sold by our selling stockholder pursuant to our RegistrationStatement on Form S-1, as amended (Reg. No. 333-146167) that wasdeclared effective on January 24, 2008. We did not receive any proceedsfrom the sale of the shares by the selling stockholders. Our net proceeds fromthe offering were $193.9 million, after deducting underwriting discountsand commissions and approximately $3.5 million of offering expenses.

 

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

 

**Item 3. Defaults Upon SeniorSecurities**

 

None

 

**Item 4. Submission of Matters to aVote 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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*                                         Filed herewith.

 

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**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Act of 1934, the registrant has duly caused this report to besigned on its behalf by the undersigned; thereunto duly authorized this 5th day ofNovember, 2008.

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

 

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