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Executives

Cheryl Gustitus - Head of Investor Relations - 3rd-1:10

Ethan Berman - CEO

David Obstler - CFO

Analysts

George Staphos - Banc of America Securities

Kelly Flynn - Credit Suisse

David Scharf - JMP Securities

Ivy De Dianous - Fox-Pitt Kelton

Peter Appert - Piper Jaffray

Michael Weisberg - ING

RiskMetrics Group, Inc. (RMG) Q4 2008 Earnings Call February 19, 2009 10:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the Q4 2008 RiskMetrics Group Inc., Earnings Conference Call. My name is Becky and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this call. (Operator Instructions).

I would now like to turn the presentation over to your host for today’s call Ms. Cheryl Gustitus, Head of Investor Relations. Please proceed.

Cheryl Gustitus

Good morning and thank you for joining us today to discuss RiskMetrics Group's fourth quarter and full-year 2008 financial results. With us today are Ethan Berman, CEO of RiskMetrics Group; and David Obstler, CFO.

This conference call is being recorded on behalf of RiskMetrics Group and consists of copyrighted material that may not be recorded, reproduced, retransmitted, rebroadcast or downloaded or otherwise used without RiskMetrics’ express written permission. Your participation in the question-and-answer session constitutes your consent to having any comments or statements you make appear in any transcript or broadcast of this call.

Information provided during this call will include certain forward-looking statements. These statements relate to future events or to future financial performance and involve known and unknown risks, uncertainties, and other factors that may cause our actual results, levels of activity, performance, or achievements to be materially different from those expressed or implied by the forward-looking statements made in the call. You should not place undue reliance on forward-looking statements.

Conference call remarks also will refer to certain pro forma results, which assume that the January 11, 2007 acquisition of Institutional Shareholder Services closed on January 1, 2007 and the August 1st acquisition of CFRA also occurred on January 1, 2007. This is a non-GAAP financial measurement that management believes facilitates a competitive analysis of developments in the Company’s business. Reconciliation of non-GAAP financial measures to the nearest GAAP equivalents are included in Tables D and E of RiskMetrics’ earnings release, which was issued earlier today and is accessible on our website at www.riskmetrics.com.

It is now my pleasure to introduce our Chief Executive Officer, Ethan Berman.

Ethan Berman

Thank you, Cheryl and thank you every one for joining us this morning for our quarterly call. RiskMetrics continue to deliver strong financial results for the fourth quarter and for our first full-year as a public company against the backdrop of unprecedented financial market conditions.

On a consolidated basis, we achieved pro forma annual revenue growth of 17.1%, adjusted EBITDA growth of 32.1% and we expanded EBITDA margin by 380 basis points, which reflects a strength and resilience of our product, services and business model.

While we continue to see good market demand and a healthy sales pipeline for our risk systems and compliance driven Governance products, the disruption in client end markets is lengthening our sales cycle and pushing renewal rates down below historical levels.

In the fourth quarter, we felt the impact of the financial challenges in face of our clients as our overall renewal rate declined to 84.2% and the rate of revenue growth slowed. However, we continue to experience revenue growth of over 20% in our Risk business with particular strength in the asset management and hedge fund segments, across the US and Europe.

Realizing the significant economies of scale as a result of our technology investments in both Risk and governance, we delivered record margin expansion in 2008, significantly above even our own expectations.

Cash flow has been and continues to be very strong. Cash flow from operations was $84.8 million in 2008 nearly double that of 2007 given it’s a cash position of over $170 million at year end.

Given that we are all seeing firs hand decline in current market evaluation multiples we have taken $160.1 million impairment charge on the lower evaluation of the goodwill associated with ISS and CFRA acquisitions this quarter. Which will result in a loss of $2.43 per share compared to income of $0.02 in the prior year.

Excluding the impairment charge Q4 2008 earnings per share would be $0.13 versus $0.02 for Q4 2007. Adjusted earnings per share for Q4 2008 and full year 2008 were $0.20 and $0.64 up 80% and 110% over the same period in the previous year.

Throughout 2008 our financial results have remained strong despite disruption in the financial markets. That said our clients have been negatively impacted by the market downturn, with significant assets under management loss consolidation redemptions. This created and will continue to create two conflicting trends impacting our recent and future results.

We have and will continue to benefit from the increased focus and need for better Risk management tools across global financial institutions. While suffering the negative impacts of a consolidating end market where business activity is increasingly slow and our renewal rate is below our long term trend.

We continue to see this picture in 2009 as longer term positive demand trends are offset by disruption in our existing and future customer base. The pace of new regulation particularly in the US altered its balance in 2009 and beyond.

As I said earlier revenue growth was strong across the board in the Risk business we continue to experience healthy demand for our products although new sales were slower to close and renewal rates declined, particularly in the hedge fund market.

On the Governance side demand for our compliance driven products remained strong while new sales and renewal rates fell far from more discretionary products like CFRA and [MNAH].

In terms of ACV or annualized contract value our year end results give us a firm footing going into the New Year. ACV increased 14.3% for the year ended December 31, driven by growth of new Risk sales in both the alternate investment and asset management segments, in the Americas and EMEA.

In Q4 ACV was down slightly from Q3 as strong new sales were offset by lower renewal rate and the waiting of renewals toward fourth quarter especially in our Governance business. To be clear new sales were higher in Q4 than they were in Q3. And we expect Q1 '09 ACV to be higher than our current Q4 ACV.

Disruption in the hedge fund market Risk and pricing pressure and our Governance businesses combined wit the overall need of our clients to cut cost and tighten operating expenses to just put unusual stress on our renewal rates. Overall our fourth quarter renewal rate was 84.2% while the renewal rate for the 12 months ended December 31 was 86.3% compared with a rate of 91.4% a year ago the more discretionary corporate service and CFRA product lines proved to be particularly vulnerable, as the financial markets deteriorated further throughout the year.

Let me take this opportunity to update you on some of the investments we are making in each of our businesses. And then I will turn it over to David to take you through our financials and 2009 guidance in more detail.

You will recall that we announced in October that RiskMetrics was entering the performance attribution space through our acquisition of Applied4 a specialist provider for performance measurement attribution solutions.

Progress in building these capabilities on top of our existing technology architecture is going well. And we expect to be working with several large pay declines in the first half of this year.

Although we are not expecting to generate any significant revenue from this new service in 2009, we have been pleased with market's positive reactions to putting Risk and returns together on one platform.

Development of our new proxy voting platform is also progressing on schedule if not perhaps, even a bit ahead of schedule. This new technology solution will help us to achieve significant headcount and operational efficiencies. It will allow us to grow our margin at ISS and provide far more efficient service for our clients.

We are well on our way to completing the voting platform and we will begin migrating clients after this year's proxy season. Our plans for 2009 and 2010 including rewriting the Proxy Research delivery platform in ISS and consolidating market and client data platforms across all of RiskMetrics.

As we have said previously we plan to continue invest in technology to build increased functionality for our clients and increase our operational efficiency.

2008 showed us once again that our highly scalable business model continues to allow us to increase margins and simultaneously invest in future growth.

Finally, the market downturn has created some good M&A opportunities for us. We are seeing a flow of bolt on acquisition possibilities that can help to deepen our Risk and Governance Services.

Today we announced that RiskMetrics has signed definitive agreements to acquire Innovest, a leading provider of sustainability research and ratings to institutional investment community for approximately $16 million in cash.

We see that environmental factors like climate change and sustainability are increasingly playing a role in the way regulators oversee and funds invest and view their portfolio Risk.

The acquisition of Innovest and largest RiskMetrics footprint in the environmental, social and Governance space at a time when the financial communities and regulators interest in sustainability are growing.

This transaction is expected to contribute approximately $6 million revenue for the ten months from our expected closing date of March 1, to December 31, 2009 and is expected to be accretive to EBITDA by adding $2 million to $2.5 million of adjusted EBITDA on an annual basis.

We are also exploring numerous other Risk opportunities around the view that in the aftermath of the financial crisis, we are going to see more Risk regulation in the financial industry going forward.

In general, regulation has been a key driver to our business growth and we are confident that this will remain the case in the next few years.

To conclude, we are pleased with our results the fourth quarter and for our first year in the public market. We achieved revenue growth of 17.1% grew our adjusted EBITDA on a pro-forma basis of 32.1% for the year and significantly expanded margins.

Although, lower renewal rates has slowed the growth rate of revenue we believe there are scalable operating models capable of continuing to deliver EBITDA growth as previously guided even in the current market environment.

With that I will now turn the call over to David to provide additional detail on our financial results.

David Obstler

Thank you, Ethan. As Ethan mentioned earlier we continue to build upon our strong 2008 with solid fourth quarter results particularly in the area of EBITDA margin expansion and cash flow generation.

I will discuss our fourth quarter and full year financial performance as well as our sales and renewal results and give a flavor of what we expect in the coming year. I will then provide updated guidance for 2009.

Turning first to revenues. Total consolidated revenues for the fourth quarter were $75.5 million, up 11.6%, while revenues for the 12 months were $296.4 million up 17.1%.

Q4 revenues were flat relative to Q3 due to the decline in renewal rates, the weakening Euro and British pound and more deferral of corporate compensation advisory revenue offset by increased new sales.

The consolidated revenue growth was driven by Risk which experienced a 21% quarterly and a 27% annual revenue growth.

Specifically, our 34% annual RiskManager revenue growth was driven by new Risk sales to hedge funds and asset management clients in the US and EMEA and by solid renewal rates of more than 90% among asset management and banking clients.

Our revenue growth was relatively balanced geographically. With Q4 '08, Americas revenues growing by 26% and EMEA by 17% compared to Q4 '07.

On an annual basis, 2008 Americas revenue grew 25% while EMEA grew 27%. ISS revenues for the fourth quarter were up 2.3% over Q4 '07 and 7.4% for the year.

For the quarter, total Governance Services revenues consisting primarily of Proxy Research and Voting Services, grew by 4.6%. While FR&A revenues declined 2.3% relative to Q4 '07, due to lower CFRA revenues and increased deferral of Corporate Advisory Services revenues due to the timing of those sales and the provision of the related services.

I will now discuss the main drivers of revenue and ACV, renewal rate, new sales and currency.

Our renewal rate for 2008 was 86.3%, down from 91.4% in the previous year and below the bottom end of our previous guidance.

Our renewal rate for Q4 declined to 84.2%. Overall, the main reason for the lower renewal rate was a decline in the renewal rate in our Risk hedge fund sector and lower rates in our more discretionary businesses at ISS, including our CFRA and Corporate Services businesses.

Despite a challenging market environment, we had very solid renewal rates in our more compliance and regulatory businesses in the asset management sector as discussed below.

On the Risk side our renewal rate for the year was 87.1% versus 91.1% a year ago. As mentioned the main reason for this decline in the Risk renewal rate was a decline in the Risk hedge fund renewal rate due to AUM losses, liquidations and consolidation. Mainly amongst new launched small to mid-size and single strategy funds.

Our Risk hedge fund renewal rate declined from just under 90% in '07 to just under 80% in '08, despite the fact that we tend to sell to larger multi-strat hedge funds with an average AUM of $5 billion to $5.5 billion.

Despite the lower hedge fund renewal rate, new sales to the hedge fund sector in 2008 grew by 30%, reflecting strong demand from that market, resulting in a 16% ACV growth in that sector above our 14% overall ACV growth rate.

The decrease in the hedge fund renewal rate was offset by a strong 90% plus renewal rate in the Asset Management segment where many of client requirements are regulatory and a solid 90% renewal rates.

On the ISS side the story was similar with the renewal rate declining from 91.8% in 2007 to 85.4% in 2008. The renewal rate as mentioned earlier was weaker in the more discretionary corporate and financial research businesses with renewal rates there down 7% but remained solid, a solid 90% in the Proxy Research and Voting business where regulation comes to play.

The renewal rate in the Proxy business dropped only 2% in 2008 compared to 5.4% for ISS as a whole. The ISS renewal rate last year in '07 did not include a full year at CFRA.

Moving to new sales, our consolidate new ACV sales for the 12-months ended December 31, 2008 were $72.4 million, 24% ahead of the prior year. Risk was particularly strong with $47.9 million of new sales up 30.6% over the previous year. What's been driving Risk sales has been consistent all year, strong growth in the US and EMEA up 32% and 30% and strong growth in the hedge fund and asset management sectors, up 27% and 40%.

After a very strong first half of the year, new ACV sales dropped in Q3 due to the worsening market conditions. While we expected Q4 to be similar to Q3, we experienced a stronger new sales performance in Q4 than we had expected, with $16.7 million of new ACV sales, an increase from $14.8 million in Q4, '07 and $13.7 million in Q3, '08. Of the new sales, $9.3 million were Risk and $7.4 million were ISS.

In Q4, we continue to experience strong new sales of RiskManager in US and Europe in both the hedge fund and asset management segments, as well as solid proxy new sales in the US and EMEA.

Sales of our securities class action services line in the US were also very solid. We continue to see strong demand for our products but the sales cycle as Ethan mentioned is lengthening in the current environment. Given these market conditions and some seasonality effects, we expect Q1, '09 new sales to be lower than those in Q4, '08.

One-time sales, mainly at ISS were $20.6 million in 2008 and $6.1 million in Q4, '08 up 10.8% and 21.5% over the prior year's periods mainly due to strong sales in the corporate product line.

Lastly on currency, our Q4 '08 revenue was negatively impacted by $0.7 million or 700,000 due to decline in the currency valuation of the euro and the pound. As we discussed on our last earnings call, about 20% of our revenues are on foreign currencies mainly in euros. With the euro and pound currently trading at about 15% below their average rate of last year, we expect an approximate $5 million to $7 million or 2% revenue reduction due to currency in 2009 relative to 2008.

This is expected to be partially offset by decline in operating expenses mainly in the British pound which began to benefit our costs in Q4 '08 as we will discuss below. As we said in our previous call about 5% to 7% of revenues are un-hedged across the basket of currency exposures. Our total ACV at December 31, 2008 was $286 million up 14.3% over the previous year and down slightly from Q3.

Risk ACV grew 21.6% and ISS grew 6.1%. While we find a strong $16.7 million of new ACV in Q4 we lost $17.1 million of ACV due to non-renewal and $1.5 million of ACV due to currency depreciation. In addition, to the lower renewal rate in Q4, the flattening of ACV was due to the seasonality in our renewal cycle where our renewals are weighted towards the fourth quarter particularly in our Governance business.

Alternative investment market ACV as I mentioned grew 16% and asset management grew 13% in 2008.

Turning from revenues to profitability, consolidated adjusted EBITDA increased 35.8% in Q4 to $29.2 million, resulting in EBITDA margin of 38.6. For the 12-months, EBITDA grew 32.1% to 101.1 with the EBITDA margin of 34.1.

As said before, this represents a margin expansion of 380 basis points, significantly above our 150 to 200 basis point target. Our EBITDA margin expansion was driven by revenue growth of 17.1% compared to EBITDA expense growth of 10.5. Our business model is proving to be more scalable than we had originally thought, even while continuing to spend for future growth.

Both businesses experienced significant margin expansion in '08, with Risk margins increasing by over 500 basis points and ISS margins increasing 230 basis points. Compensation expenses decreased 2.1% in the fourth quarter relative to last year and increased 7.5% for the year.

We have maintained control over our headcount growth, which only grew 6% year-over-year from approximately 1,040 employees a year ago, to 1,100 employees at year end '08. We planned to maintain headcount at relatively flat levels in 2009, as hiring in growth areas is offset by reductions in those areas where we have made technology investments like our Proxy and Voting platform.

Contributing to lower compensation expense in '08, with also lower commission expenses and flat benefit cost. Non-comp expenses increased 5.3% for the quarter and 17.2% for the year, mainly due to increases in occupancy, accounting, telecom data and travel. The rate of growth of our non-comp expenses slowed in Q4 and we expect that to continue in 2009 as we made 2008 investments in Sarbox compliance and other public company costs, expanded our data center infrastructure, grew our office space and made increased data purchases in 2008 all of which were flat in 2009. Q4 '08 adjusted EBITDA increased $4.1 million compared to Q3 '08 despite revenues remaining flat on a sequential basis.

Non-comp expenses in the quarter were flat compared to the previous quarter. The increase in adjusted EBITDA was primarily due to a $4.1 million or 12% decline in compensation costs due to lower bonus and commission expenses as well as declines in foreign currency losses.

As mentioned earlier, declines in the value of the British pound and euro currencies may have a negative impact on revenues. However, such declines are partially offset by natural hedges of our operating expenses in foreign locations. In addition, our ability to control costs including headcount had allowed us to continue to grow revenue at a higher rate and expense growth as evident by our continued decline in expenses through the second half of '08.

Moving briefly to our fourth quarter impairment charge, in the fourth quarter we recorded a non-cash impairment charge to goodwill and intangible assets of 160.1 million as a result of the company’s annual goodwill and intangible impairment review. The goodwill impairment write-down was 154.2 million as a result of significant declines in industry market multiples during the second half of the year.

In addition, an impairment charge was taken 5.9 million to mark down an ISS intangible asset related to a trade gain of which the expected life of that trade name was deemed to be reduced.

On net income as a result of $160.1 million non-cash impairment charge we reported a GAAP net loss and EPS loss for Q4, '08 and the full year.

Excluding the impairment loss, GAAP EPS for Q4 would have been $0.13 per share and for the full year $0.31 per share. Further adding back amortization of intangibles, one time costs and stock-based comp where adjusted EPS was $0.20 per share in Q4 and $0.65 for the full year.

On cash flow we continued to have a very strong cash flow generation, production in Q4 and 2008 as a whole, significantly above our expectations. Cash and cash equivalents were $170.8 million at year end up $19.1 million over Q3 and $143.3 million compared to a year ago. Operating activities contributed $84.8 million nearly double '07 including $26 million generated in Q4 alone.

In 2008, we generated almost $20 million of cash from working capital amount complemented by paying only $3.6 million of cash tax compared to our provision of $10.7 million due to the use of NOLs.

In 2009 with our NOLs largely used we expect the cash tax and book-tax would be approximately equal.

Free cash flow or operating cash flow less CapEx increased to $76.1 million in 2008 versus $34.3 million in '07. CapEx in fact decreased from $11.1 million in '07 to $8.8 due to the less data center and real estate projects in '08.

We also have a very strong liquidity position with net debt of $120 million and net debt to LTM EBITDA ratio of 1.2 times. All of our cash is invested conservatively in short-term treasury and US Government guaranteed instruments.

In closing, RiskMetrics Group produced strong financial results for the fourth quarter. As Ethan mentioned, we delivered strong top line growth, improving margins, and strong cash flow growth in a challenging market environment.

While we see a slower growth in our top line, given the disruptions in the end market, we believe that our business model and scalable and controllable cost structure will allow us to deliver strong margin growth even in the weaker revenue environment. We believe we can accomplish this even while investing in new product such as performance attribution and sustainability research.

With that, I would like to turn to our updated 2009 guidance. With respect to our outlook for 2009, we have updated our revenue guidance take into account our current view of the market and impact on 2009 new sales and renewal rates.

We also have take into account prevailing currency rates and included the impact of the Innovest acquisition.

The result is a lowering of our 2009 revenue range to $315 million to $330 million versus $325 million to $340 million range discussed on our previous call.

The lower end of this range anticipates lower 2009 renewal rates, reduced new sales and weaker euro and British pound. Despite the reduction in revenue guidance the company still expects adjusted EBITDA to be in the previously communicated $112 million to $120 million range with 150 to 200 basis point margin expansion.

While the 2009 margin expansion will not be as significant as 2008 the company's leverage able cost structure should allow further margin expansion while still investing in development of internal products and platforms.

Free cash flow is expected in 2009 to be in the $70 million to $80 million range, including the cash tax changes already discussed.

Capital expenditures are expected to be in the $10 million to $11 million range. Our fully diluted share count will be in the $68 million to $70 million range. And our effective tax rate is expected to be 36% to 38%.

The 2009 guidance, we are giving, includes our anticipated acquisition of Innovest which is expected to close March 1st. We are expecting Innovest to add approximately $6 million of GAAP revenue in the remainder of 2009.

With that, Ethan and I will now open the call up to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of James Cusane of Banc of America Securities. Please proceed.

George Staphos - Banc of America Securities

Hey guys, its George filling in for Jim. Congrats on the quarter. Can you guys talk a little bit about what sort of retention rates you factored into the '09 guidance you provided?

Ethan Berman

I think, we're looking at retention rates in the range of what we saw in '08, so a continuation of that. I think that greater percentage of our book of business is regulatory driven or compliance driven, which is naturally happening the less of our book, which is discretionary, which is naturally happening. It will mean the natural tendency for the renewal book to continue to go up in rate and offsetting that would be what we expect to be a continuing difficult environment. Certainly for the beginning of 2009 and perhaps for the entire year, so, that puts us around where we have been for 2008.

David Obstler

The range anticipates a couple 100 basis points; north and south of last year's performance.

George Staphos - Banc of America Securities

Got you. Okay, and what percentage of contracts came up for renewal in the fourth quarter and do you have that for the first quarter?

David Obstler

Yeah, in the fourth quarter it was approximately which is the highest Governance way of the quarter approximately 40%. And that was due to the Governance business as well as to success we had during the year, in up selling clients whose mid-year, whose renewal time period was coterminous with the end of the contract which was in those cases at the end of the year. And in the first quarter its 20%. So unlike the fourth quarter where we have a significant amount up for renewal and every year we have a flatter ACV development from Q3 to Q4 because of that, we then have one of our lowest renewal quarter and the first quarter of about 20%.

George Staphos - Banc of America Securities

Got you.

Ethan Berman

There has been trend towards an increased percentage of our revenue renewals in the fourth quarter.

George Staphos - Banc of America Securities

Its okay and I think you would mention for the first quarter you are looking for new sales growth to come down sequentially. Is that mostly going to be on the risk side of the business and can you also talk about pricing trend that you are seeing across both operating segments?

Ethan Berman

That will be on both businesses, I think there is a significant calendar effect and as David mentioned, he is one of people who sort of want to spend their budget before it disappeared at the end of the fourth quarter in both businesses and on the Governance side you tend to chose your Proxy Advisor by the end of the year to prepare for next season.

So there were not a lot of new sales on the traditional Proxy Voting business in the first quarter. As far as pricing pressure, we are seeing that throughout our businesses more on the Proxy side than on the Risk side but some are that on the Risk side. I think more than anything it comes from internal pricing pressure in the sense that everyone is told to cut budgets rather than we have a contemporary new space is coming out with significantly lower prices. Again we see some of that in some markets, but the majority of it is just environment where people are trying to reduce spending.

George Staphos - Banc of America Securities

Great. Thanks guys.

Operator

And your next question comes from the line of Kelly Flynn of Credit Suisse. Please proceed.

Kelly Flynn - Credit Suisse

Hi everyone, couple of questions. First on margin, you said you are getting better than expected leverage, but could you just elaborate on how much of the upside this quarter as well as your forecast for next year is driven by, lower comp return on Wall Street and your company specifically versus actual leverage coming in better than expected. And then I got a couple of others too thanks?

David Obstler

Yeah I don’t think the comp trends are the big driver here as I think we have discussed in previous calls well, we clearly hire many people from Wall Street firms and or compete with Wall Street firms for talent. We have never had a Wall Street like compensation plan. So I do not think you will see given the bonuses are down 60%, 80% that Wall Street firms that’s going to be reflected here at RiskMetrics.

I think we did get a benefit from a currency impact in particular the fact getting somewhat technical that we have a large bonus payment in sterling, because we have a large UK staff and that bonus payment is paid at the average 12 month sterling rate and that was significantly higher than where we actually bought sterling. So this particular year the comp expense was $700,000 lower just from a currency fluctuation, so that in a slightly lower sales than we had forecast after the second quarter when we re-forecasted commissions drove the lower comp as well as the lower headcount not a significant reduction in bonuses because the overall markets are down.

Ethan Berman

The major factors for next year are not the average comp per head it's the headcount increase on the comp side and then on the non-comp side the rate of growth is slowing down as there were number of investments need in '08 that won't be increasing at the same percentage in '09 as they get in '08.

David Obstler

It's very succinctly the average compensation plan for 2009 per employee is higher in 2009 and 2008 in our plan as it is today, but to point out sort of investments there was the sort of $5 million investment in our new Voting platform they were obviously Sarbox expenses first time of the company expenses that obviously we will not have in '09 or in '08 that lower number.

Kelly Flynn - Credit Suisse

Okay. And then what about, you said in a release and I think you touched on in your comments technology investment having paid off as far as delivering more leverage, can you elaborate on that?

Ethan Berman

It's primarily headcount in the fact that we are as David said this year we plan to have flat headcount with actually some chance of lower headcount despite the fact that we are adding people to all our growth businesses. So, the operational elements of our business which were and had been very manually intensive due to old technology we have been able to replace people and operations and procedures using that technology. And I think that will continue through '09 and you will see that in 2009 and at least in 2010 it's not beyond.

Kelly Flynn - Credit Suisse

Okay. Just related to ISS, I think I understand why you had the good will write-down, but just in light of that, can you address kind of what was paid for that company with hindsight, does that appear too much? Is the strategy working as far as cross-selling? Maybe just kind of an update on how you are looking at the whole thing as it laid out over the last of couple of years?

Ethan Berman

Well, clearly, if the company was for sale today, you wouldn’t pay the same price for it. Having said that, we paid for most of it through debt that we wouldn’t had paid the same price for either and some stocks which also we wouldn’t have been able to if there was any higher price than today's price for RiskMetrics, despite the fact that company is obviously two years later and performed quite well. So, multiples will all come down into that end. I think we paid more than we should have and we used stocks, that was more expensive and debt that was more expensive.

I think in terms of cross-selling and the strategy, we have found that the diversification has helped us, that we have been able to leverage infrastructure across those businesses and that both businesses are benefiting from paying reduced costs for whether it be G&A or other technology infrastructure that either one on their own would be paying the full freight for. So, we are getting those benefits. We do have an integrated sales force. I think cross-selling was?

David Obstler

Cross-selling has been in $2 million to $3 million a quarter. It's been increasing, fourth quarter was the highest cross-selling quarter, we started out more like one at the beginning. So, we have experienced some success, just to add to Ethan's comments about the accounting and the goodwill. This was not a matter of the ISS business unit and EBITDA performing under budget. The growth since we bought this in the 15% to 17% range of EBITDA and that’s been as we planned this is a matter of that we paid a multiple I think we said previously was in the upper teens and the market valuations in the stock market have gone down for a comparables and that as you see from many companies and we experienced that requires a goodwill impairment based on the goodwill test.

Kelly Flynn - Credit Suisse

Okay. Thank you very much.

Operator

And your next question comes from the line of David Scharf of JMP Securities, please proceed.

David Scharf - JMP Securities

Thank you. good morning. Few things I would like to cover; first, dwelling into multi-asset performance attribution, it sounds like the earlier acquisition is off to a good start at least in terms of getting some data clients up and running this first half. Trying to get a sense for ultimately how significant a revenue opportunity this is, has there have been any discussion yet in terms of what you expect this type of product to sell for, it’s on base level?

Ethan Berman

Yes, its in the hundreds of thousands of dollars a year, not the 10’s or million’s and that could range from the low end of that to the high end of that. So, I think you will see average sale prices in the sort of $200,000 to $500,000 per year. I think that is primarily going to be an asset management [sold] asset managers which at this point represents over half of our existing revenue, and so we fit in quite nicely with that group.

David Scharf - JMP Securities

Okay, so it’s generally, probably inline with the average contract size within Risk as a whole?

Ethan Berman

Yes it will be slightly lower than the average in the sense that the managed services component of Risk will be the same as the managed services component of performance attributions like we don’t have to pay for it twice. But if you strip our managed services and you look at just the risk tools and analytics, it will look very similar to performance. And ultimately our goal, of course, would be to sell both the tools plus the managed services. So, any client who is paying for two of those already is going to be a 50% increase, anyone who is buying just one you have the chance of tripling that contract.

David Obstler

The RiskManager market product line is $125 million to $130 million product line for us, that’s the target market. That’s mainly a buy side market and that will be the target market, so 10% penetration of that would be $10 million to $15 million revenue development.

David Scharf - JMP Securities

Okay. And what exactly is the timeline in terms of how long the pay declines will be testing when you actually expect to have people outselling this in a material way for early next year.

Ethan Berman

We will be disappointed not to have made sales in the fourth quarter of '09, obviously given the revenue model, you won't see you will see very limited amount of that revenue recognized in '09 anything we signed in the fourth quarter, though obviously be primarily a 2010 revenue impact. And again we will be disappointed if didn’t start seeing that in 2010.

David Scharf - JMP Securities

Great, thank you. And couple of other things, on the headcount front it looks like it will be largely flat but there's still going to be hiring in some areas. I think last quarter six months ago, you were still forecasting increased sales headcount in Europe. Is that still the case and if not what are the areas we are adding headcount this year?

Ethan Berman

We do have some additional heads in sales a small number that are handful. We have some additional heads in technology. We are opening an office in Beijing in April, which will be somewhere between 10 to 20 individuals who will be doing primarily R&D, primarily around analytic's, qualitative data and modeling that has been a very successful program that we developed with three universities in Beijing but they have been sending us through the summer interns to New York, and we have been very pleased with the talent that we have been able to find there and then they will go back and then work in our Beijing office.

So, we got some hundreds of applicants and I believe at this point hired at least 8 of the sort of 10 to 12 we plan to start with.

David Obstler

Headcount will go up little bit in the first half of the year and then as we kept proxy season and realized some of the technology investments we will go down and then it will go up in March for the Innovest acquisition.

David Scharf - JMP Securities

Got you. Switching to renewals in the outlook here. Obviously Q4 is seasonally the most concentrated, so at the beginning of the year you don’t have as much risk. I am just trying to get a sense in the alternative investment arena. How much heads up, I mean how much visibility to your account manager's have in the beginning of the year as it relates to hedge fund attrition? I mean we are in obviously a very unique environment to open 2009 a lot of shops that have been faced with a lot of redemptions or may just decide to shut their doors because they are so far below their high water mark. Do you feel like you have a really good sense for how much of your installed base and it has not shut the door yet, will in fact do so in the first six months of this year?

Ethan Berman

Hard question to answer, its one of those. Yes, we do. But then you read things that you did not believe the day before. So, clearly as we did our forecast of renewal rates, we incorporated any one we know has shut, will shut or is in significant trouble. We do not go to the next level of saying well we know their assets under management are down. And so, let's therefore, lower the likelihood of renewal for that hedge funds.

At this point, the biggest attrition of hedge funds that we saw were all classified as new or multi-billion dollar new launches, where in, 2007 beginning of 2008. You saw a significant amount of very large new multi-strategy hedge funds launched. They often launched buying our product day one as it was part of the marketing pitch to investors, providing risk transparency. It was a very short sale cycle, and price was not an issue. And we have seen a significant number of those not making.

And obviously, all of those because they are high profile and they were launched recently, you have good insight into. What we have at this point is a base of hedge fund clients that are in the, have been in the business for a much longer period of time. And while there is always a story about how their results were in redemption, rumors, et cetera. We have no sort of more insight than any one else, and there is a likelihood that those funds will shut down in sometime in 2009.

David Obstler

David, our hedge fund business is about 18% of our ACVs is a $50 million business largely in Risk. So a 10% movement of, in the renewal rate we experienced last year is a $5 million ACV and about, half of that $2.5 million revenue element. So the combination of doing the renewal rate planning across all the sectors client-by-client in 2000 putting in what we anticipate taking that down in our planning. And then the pacing of the renewals, renewal rates that affect but as Ethan mentioned. We do not know everything is going to happen then hence a lot of stuff happened in the year to change that.

Ethan Berman

I should give a comment, I have make in, I know there is lots of sensitivity about hedge funds these days is that at the same time new sales hedge funds continue to be strong and that is because I think there is a clear movement toward increase transparency in hedge fund investing whether it be a improved best practices. As institutional investors basically no longest work on, I trust you, here is your money, here is my money, just make money for me and or what I think is more likely some regulation that we are requiring.

So our view of the hedge funds space we think is still a very attractive space for this firm going forward despite what is obviously going to be a lot of volatility.

David Obstler

I already mentioned, the hedge fund sector grew 16% last year versus ACV growth of 14 and a revenue growth rate of 17. So it was a strong contributor to the growth in 2008.

David Scharf - JMP Securities

Right, and I think along those lines are the past you mention that, RiskMetrics currently has. I mean roughly a 100 of, the 500 largest hedge fund complexes globally of the 400 that are still out there can you talk about broadly where they are located, whether you are sensing any acceleration in potential new sales into the area. I mean it sounds like, I understand the sensitivity analysis David, with respect to the small percentage impact on revenue given the percentage of ACV from alternative assets. But by the same token it's a disproportionate amount of your new sales. Can we get a sense perhaps but when that 100 of the top 500 goes to a 150, is that a three year process, one year or five year?

Ethan Berman

Unfortunately, we are having more dialogue with those other 400 than we have had in the past. So the amount of information flow between us and them has actually gone up in this environment, not down. The other side of that is their speed of movement which in hedge funds sector had been the fastest sales cycle has slowed dramatically.

So it's a strange dynamic that way. Our expectation is that the sort of going from 100 and 150 in that three year time horizon is certainly well within our expectations. We would love to see that happen faster, due to a more rapid movement to already the best practice or regulation. And to reiterate of those 400 the vast majority do nothing with any external help.

David Scharf - JMP Securities

Got you.

David Obstler

Last years new sales story David was a combination of as Ethan mentioned, new launches earlier, but also real trend towards that as you are speaking about large established hedge funds becoming new clients and we had very large new sales in all the quarters including the fourth quarter of last year and the hedge fund market.

What Ethan was alluding to is that trend was out there long term trend has slowed a bit because of the end market dislocation, but it's premise still out there and even in the fourth quarter we had some very large new hedge fund sales to large hedge funds.

David Scharf - JMP Securities

Good. And David do you have a break down in Q4 of the renewal rates by Risk versus ISS?

David Obstler

Yes, in Q4 the break down was Risk was 86% and ISS was 83%.

Ethan Berman

But ISS of course including various discretionary products.

David Obstler

I think we alluded to earlier the Proxy business the more regulatory businesses had renewal rates in the upper 80%to 90%. All of last year and including in the fourth quarter upper 80s, it's very upper 80s. And the more discretionary the corporate business and the research business had declines of renewal rates of about 7%. So that was the major driver of the 5% decline in the ISS renewal rates. The Proxy business itself declined by 2% but still it was at 90% so went from 92% to 90%.

David Scharf - JMP Securities

Alright. And $9.3 million of new sales within Risk that includes $2.9 million from that was referenced last quarter and I think was signed in Q3 but closed in Q4?

David Obstler

That would if there would be a rolling that will include deal signed in Q3 and had license take in Q4 but would not include deal signed in Q4 and there were number of them that have license dates in Q1, so it's rolling. I think you are aware $2 million to $3 million pretty much. Most quarter would be signed but not recognized in ACV. Let's remind you our ACV is not on signing it is on license day. So Q4 deal with a license date start February 1 for instance '09 would not be in Q4 numbers.

David Scharf - JMP Securities

Okay. In general as we think about new sales this year. Should we be looking at the second half of 2008 as a closed benchmark within risk?

David Obstler

Yeah. In another thing we are looking at is in 2007. We did about $58 million of new sales. So, we see '09, to be more like the second half or more something in the 50s to 60s, similar to what we had in '07.

David Scharf - JMP Securities

Okay. Perfect. Thanks so much.

David Obstler

That's been incorporated in our planning guidance.

David Scharf - JMP Securities

Got you, all right. Thank you very much.

David Obstler

Thank you.

Operator

And your next question comes from the line of Ivy De Dianous of Fox-Pitt Kelton. Please proceed.

Ivy De Dianous - Fox-Pitt Kelton

Hi, good morning. My question is the declines in renewal rate in ISS Governance was largely driven by CFRA and Corporate Services, what about that decline rates to client basis? Is it concentrated in one client area?

David Obstler

Well, CFRA it’s a different answer for both products. In CFRA, the customer base is split roughly equal between hedge fund and alternative market and the asset management. And so, the distress in the hedge fund market contributed to the decline in the CFRA product line in addition to the discretionary nature of it. The Corporate business serves corporations mainly Fortune 500 and where as we saw very strong growth in some of what we call non-recurring product lines which are the compensation products. Again, the data products are more discretionary and as corporations were looking at cost cutting we saw a different renewal rates in those product lines.

Ivy De Dianous - Fox-Pitt Kelton

Okay. My second question in the current context of financial crisis, what kind of strategic industry initiative at RiskMetrics like leading the industry in shaping and improving Risk Management in the current environment?

David Obstler

I think that we are doing our best to get into the regulatory dialogue that’s happening primarily in this country though also in Europe and other places. I think it’s pretty clear that you can see quite dramatic change in regulation of financial institutions globally and I think that’s the general trends will be to our increase transparency and obviously that plays to our strength given what we do for financial institutions.

Ivy De Dianous - Fox-Pitt Kelton

Do you foresee any changes to like the calculation of Risk methodology-wise going forward?

David Obstler

I think what you are going to get is and frankly we have seen this with our clients for quite sometime not simply in reaction to what’s happened here, but for years is what we call a picture of Risk but that it is not about one number but that it is a suite of numbers that give one insight or a picture of exposures within our portfolio. And I think that these days the treasury secretary is talking about stress testing for banks. I think almost all of our clients are using our stress testing functionality for years and again not simply in today’s environment and I think you are going to see that become much more standard. I think that obviously is much more is being spent on time, energy on areas like liquidity risk leverage as well as traditional measures of [bar], data duration.

Operator

And your next question comes from the line of Peter Appert of Piper Jaffray. Please proceed.

Peter Appert - Piper Jaffray

Thanks. The decline in compensation expense in the fourth quarter you have already mentioned this, but in the context how strong the operating results were I guess I find it somewhat surprising. Was there a reversal of prior bonus accruals in the fourth quarter. Did that impact the results?

David Obstler

There was both if you look back at obviously very strong results for year if you look through the first six months of the year, new sales were running significantly higher in Q1 and Q2, well above our expectations and at that point mid-way through the year we increased our accruals for both headcount and the dealer bonuses and commissions. And obviously as the market slowed in the second half of the year those numbers came in lower. Net our bonus pool came out to be higher than we had originally budgeted for year last this time last year, but lower than we budgeted mid-way to the year. And I think commissions worked out a similar fashion and then, of course, we had this fairly significant currency impact.

Ethan Berman

Peter really foreign currency played a role; it was more or less the pacing of the inclusion of the foreign currency effect in the bonus. We have a very large cash element payed out at the end of the year and we took the foreign currency benefit of that weakening pound in the fourth quarter.

And foreign currency also played another role through our P&L, we have the foreign currency effect of the difference of the foreign currency when we build client and we collect in our operating results. And because of the movements and volatility of the currencies, we had a negative in the third quarter and a positive in the fourth quarter.

And then overall, I think we did a very good job in the fourth quarter on cost management across the Board as we recognized the business environment. So, I think it's more of the margin picture, it's more transparent on a full-year basis rather than individual quarter and you should look at that the 380 as the margin [permit] for the year are not necessarily the fourth quarter as indicative of what's going to happen in the future.

David Obstler

And again just to reiterate is obviously compensation is an issue in finance these days, the average employees' compensation went up '07 to '08 and we expect it to go up in our current plan from '08 to '09?

Ethan Berman

Just to make very clear this was not a situation where compensation the bonus pool was just dramatically, it was a foreign currency translation effect not that which all sudden cut the bonus pool, very different than you are seeing in another company.

Peter Appert - Piper Jaffray

But the FX effect David mentioned earlier was 700,000.

David Obstler

Yes.

Peter Appert - Piper Jaffray

That's total impact in the fourth quarter?

David Obstler

That was the impact, there were other impacts in our salary and compensation line that was just a bonus translation element. So, we did benefit across rent in the UK across salaries in the UK because of the weakening pound. And I think that's why I mentioned earlier that the hurt on the top line from currency is and we said last time half to two-third made off in terms of expense reductions in those currencies mainly in the sterling.

Peter Appert - Piper Jaffray

I am sorry, but help us better understand just the financial performance of the fourth quarter. Can you tell us the dollar amount in terms of excess accruals in the first nine-months that have been reversed in the fourth quarter?

Ethan Berman

We haven’t come out that we mentioned the one in the bonus line which is $700,000.

Peter Appert - Piper Jaffray

That was just the FX.

Ethan Berman

Right. That was the translation of the bonus into currencies once we translated them at year-end rates.

Peter Appert - Piper Jaffray

Okay. I will come back to you later on this.

Ethan Berman

The other elements in the fourth quarter were, I think we said, there were $700,000 of top-line reduction due to currency movements. That would be thorough renewals that are then booked at different currencies than they were booked last year. And there was a deferral of about $700,000 of compensation advisory products where we provide that product over three to four months and the service period has lengthened as we sold that product. So, we decided to recognize that over the three to four months resulting in a deferral of $700,000 of revenues that would have been in the fourth quarter but are now going to be recognized on a deferred basis in 2009. Those are the effects.

Peter Appert - Piper Jaffray

Okay. So, overall thinking about '08 in total, margin upside obviously was very impressive, better than expected as you noted at the beginning of the year. Does that cause you, Ethan to rethink your profit targets for the next several years in terms of where you think the margins in the business might go and what do you think the upside limit to margins could be?

Ethan Berman

There is no question we think we can get margins out of business to start with a four rather than a three overtime. We still think again, as we talked, the marginal dollar today is in the 4s not the 3s. But, we do feel we are still early in this game. And despite the current market environment, we continue to invest quite heavily in technology from an operations point of view and new products and services especially on the Risk side or in general compliance areas [middle] office functions.

So, Risk today is in the high 30’s and so its easier to see that getting into 40’s but I also believe the Governance business will be done with the technology, that we have seen already and the impact and what we know we can do going forward will also be able to get there overtime.

It’s not something we are rushing to do because I think we still want to stay focused on our top-line growth, which obviously is that much more difficult given the environment we are in.

David Obstler

Peter, we went public if you recall, we said that in the 3 year time period our target was in the mid-30’s, and we were 200 basis points ahead of that on a run-rate basis. Given we said we think we can continue to maintain that original guidance of 150 to 200, that would put us in that time period above the mid-30’s, towards more of 37%, 38%.

And I think as Ethan mentioned we talked about the marginal profitability from revenue growth is in the 40% to 50%. So, the business is if we continue to run them likely been running them which is to invest the portion of the revenue growth back in the business, that leads to as we talked about previously a 40% longer-term but not in the original 3 year period, shy of that but at the higher margin that we have originally indicated.

Peter Appert - Piper Jaffray

Great. Thank you.

Ethan Berman

And Peter just let me to be clear I think if we come at the higher end of our revenue targets after the year we will come above our guidance on our margin as we did this year. I just think that given the environment right now, we want to remain cautious on where we come out on the revenue side and make sure that we continue to deliver the sort of 150 to 200 basis point margin expansion at the very least.

Peter Appert - Piper Jaffray

Great. Thank you.

Operator

And your final question comes from the line of Michael Weisberg of ING, please proceed.

Michael Weisberg - ING

Yes finally.

Ethan Berman

Hi Michael.

Michael Weisberg - ING

Hi you got to tighten these things up, that was 40 minutes for four people, you can not do that. Just closer first of all you mentioned $58 million in '07, I think you said Risk that totaled was it right.

Ethan Berman

That was total new ACV in '07.

Michael Weisberg - ING

Right. The new acquisition will be part of ISS.

Ethan Berman

Yes, part of the ES&G business in ISS.

Michael Weisberg - ING

What did you say about the low end guidance, did you say it was reflected lower, weaker European and Euro and Pound. I thought you said that, do you mean weaker than it is now, weaker or was it at beginning of the year?

David Obstler

There are three effects first of all renewal rates we said our plan that is this year's renewal rate plus or minus 200 basis points. So the lower end would be toward the lower end of that. We said that our performance for 2009 we anticipate will be similar to 2009 which was around $58 million to $60 million and therefore the lower end of the range would be below that, shy of that and then on currency we had planned last year we planned the Euro was about 130, low 130s and the pound was about 160. And both have depreciated from there and therefore the lower end of the range looks at today's currency rates in planning for 2009.

Michael Weisberg - ING

Okay. Great, that’s quite on that end. Again Peter tried on the sales and marketing side I guess what he was driving at what I want to understand is how are we suppose to look at that in terms of going forward. Do you want us to take the sales and marketing as the percentage of sales for the full year and use that as the best proxy going forward?

David Obstler

Yes.

Ethan Berman

Yes.

David Obstler

Yes, because there is seasonality of marketing where in the case of the fourth quarter the marketing problems were largely completed and there was not a lot of marketing investment. And in terms of the commissions, the commissions were recognized because of certain cash involvements more quickly than might be pro-rata and there was currency, so I would use the full year when looking at next year's picture.

Michael Weisberg - ING

Yes, same thing about R&D because you had step down in the R&D in the fourth quarter.

David Obstler

Yes, and that would be a similarly look at more of the full year. There has been margin improvement real margin improvement in each of the quarter. So I would do some normalization in looking at the fourth quarter. The fourth quarter had compensation I think we said there was a $4 million less than third quarter and that's not the way we are running the business, that was due to foreign currency timing of accruals the bonus accrual timing and also commission timing. I think that flows through of course in the bonus that flows through into each of the accounting categories.

Michael Weisberg - ING

Got it, great could you quickly, what were new orders fourth quarter '07 in the two categories?

David Obstler

In two categories, in fourth quarter of '07 the new orders were 14.8 including 5.2 at ISS and 9.7 at Risk.

Michael Weisberg - ING

Great. Thanks a lot. Take care guys.

Ethan Berman

Thank you.

Operator

And there are no further questions at this time. I would now like to turn the call back over to Mr. Ethan Berman for closing remarks.

Ethan Berman

Thank you all very much and we look forward to talking to you again next quarter.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.

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Source: RiskMetrics Group, Inc., Q4 2008 Earnings Call Transcript
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