SEI INVESTMENTS CO - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations.

(Edgar Glimpses Via Acquire Media NewsEdge) (In thousands, except per-share data) This discussion reviews and analyzes the consolidated financial condition at December 31, 2012 and 2011, the consolidated results of operations for the years ended December 31, 2012, 2011, and 2010, and other factors that may affect future financial performance. This discussion should be read in conjunction with the Selected Financial Data included in Item 6 of this Annual Report and the Consolidated Financial Statements and Notes to the Consolidated Financial Statements included in Item 8 of this Annual Report.

Certain information contained in this discussion is or may be considered forward-looking. Forward-looking statements relate to future operations, strategies, financial results or other developments. Forward-looking statements are based upon estimates and assumptions that involve certain risks and uncertainties, many of which are beyond our control or are subject to change.

Although we believe our assumptions are reasonable, they could be inaccurate.

Our actual future revenues and income could differ materially from our expected results. We have no obligation to publicly update or revise any forward-looking statements.

Overview Consolidated Summary We are a leading global provider of investment processing, investment management, and investment operations solutions. We help corporations, financial institutions, financial advisors, and ultra-high-net-worth families create and manage wealth by providing comprehensive, innovative, investment and investment-business solutions. Investment processing fees are earned as monthly fees for contracted services, including computer processing services, software licenses, and investment operations services, as well as transaction-based fees for providing securities valuation and trade-execution. Investment operations and investment management fees are earned as a percentage of average assets under management or administration. As of December 31, 2012, through our subsidiaries and partnerships in which we have a significant interest, we manage or administer $458.3 billion in mutual fund and pooled or separately managed assets, including $201.5 billion in assets under management and $256.8 billion in client assets under administration.

Our Condensed Consolidated Statements of Operations for the years ended 2012, 2011 and 2010 were: Percent Percent Year Ended December 31, 2012 2011 Change 2010 Change Revenues $ 992,522 $ 929,727 7 % $ 900,835 3 % Expenses 780,956 725,662 8 % 683,302 6 % Income from operations 211,566 204,065 4 % 217,533 (6 )% Net gain from investments 14,067 3,360 N/A 48,533 (93 )% Interest income, net of interest expense 5,192 5,244 (1 )% 4,848 8 % Other expense, net - - N/A (590 ) N/A Equity in earnings of unconsolidated affiliates 98,671 105,818 (7 )% 99,457 6 % Income before income taxes 329,496 318,487 3 % 369,781 (14 )% Income taxes 121,462 111,837 9 % 136,461 (18 )% Net income 208,034 206,650 1 % 233,320 (11 )% Less: Net income attributable to the noncontrolling interest (1,186 ) (1,691 ) (30 )% (1,633 ) 4 % Net income attributable to SEI Investments Company $ 206,848 $ 204,959 1 % $ 231,687 (12 )% Diluted earnings per common share $ 1.18 $ 1.11 6 % $ 1.22 (9 )% Significant Items Impacting Our Financial Results in 2012 Revenues increased $62.8 million, or seven percent, to $992.5 million in 2012 compared to 2011. Net income attributable to SEI increased $1.9 million, or one percent, to $206.8 million and diluted earnings per share increased to $1.18 per share in 2012 compared to $1.11 per share in 2011. We believe the following items were significant to our business during 2012: • Revenue growth in 2012 was primarily driven by higher Asset management, administration and distribution fees from improved cash flows from new and existing clients and the net market appreciation during 2012. Our average assets under management, excluding LSV, increased $13.5 billion, or 12 percent, to $130.5 billion during 2012 as compared to $117.0 billion during 2011.

• Sales of new business in our Institutional Investors and Investment Managers business segments as well as positive cash receipts from new and existing advisor relationships in our Investment Advisors business segment contributed to the increase in our revenues and profits.

Page 17 of 76--------------------------------------------------------------------------------• Our investment processing fees in our Private Banks business segment increased due to new business, higher one-time project revenue and increased fees earned on our mutual fund trading solution.

• Our proportionate share in the earnings of LSV was $100.0 million in 2012 as compared to $105.8 million in 2011. The decrease in our earnings was primarily due to lower profits caused by increased personnel costs as well as a decrease in our ownership percentage from approximately 41.2 percent to approximately 39.8 percent beginning with the second quarter 2012. The reduction in our ownership percentage is described in greater detail under the caption "Equity in earnings of unconsolidated affiliates" later in this discussion.

• Our operating expenses related to servicing new and existing clients implemented on GWP increased during 2012 as we continue to build out the operational infrastructure. These increased operational costs, mainly related to personnel and third party service providers, primarily impacted the Private Banks business segment. The increased operational costs are primarily included in Compensation, benefits and other personnel on the accompanying Consolidated Statements of Operations.

• Our consulting costs incurred for the development of GWP, excluding amounts capitalized, have declined during 2012 as compared to 2011. These consulting costs, which are expensed as incurred, are included in Consulting, outsourcing and professional fees on the accompanying Consolidated Statements of Operations.

• Our operating expenses related to our hedge fund and separately managed accounts solutions of our Investment Managers business segment increased during 2012 as compared to 2011. These increased operational costs, mainly related to personnel, resulted from servicing new and existing clients and are also included in Compensation, benefits and other personnel on the accompanying Consolidated Statements of Operations.

• Sales events, net of client losses, were significantly higher during 2012.

These sales events resulted in an increase in sales compensation expense of $12.8 million when compared 2011. Also, incentive compensation expense increased in the 2012 as compared to 2011.

• Amortization expense related to capitalized software increased to $32.6 million during 2012 as compared to $26.2 million during 2011 primarily due to continued releases of GWP. Additionally, we decided to discontinue the use of specific functionality within the platform and incurred $2.7 million of amortization expense related to the remaining net book value of the component during 2012. This expense was recognized in our Private Banks business segment.

• We recognized gains of $13.2 million in 2012 and $3.4 million in 2011 from structured investment vehicles (SIV) securities. In November 2012, we sold our remaining SIV security, the senior notes issued by Gryphon, and recognized a gain of $5.3 million from the sale. We no longer own any SIV securities at December 31, 2012 (See Notes 5 and 6 to the Consolidated Financial Statements).

• Our effective tax rates were 36.9 percent in 2012 and 35.2 percent in 2011.

The increase in our tax rate was due to the accrual of taxes on the cumulative undistributed earnings of SEI Asset Korea (SAK) as well as the impact of the Domestic Production Activities Deduction which benefited our tax rate in 2011 (See the caption "Income Taxes" later in this discussion for more information).

• We continued our stock repurchase program during 2012 and purchased approximately 7,528,000 shares at an average price of $20.62 per share for a total cost of $155.3 million. Our stock repurchases during 2012 significantly contributed to our growth in earnings per share.

Significant Items Impacting Our Financial Results in 2011 Revenues increased $28.9 million, or three percent, to $929.7 million in 2011 compared to 2010. Net income attributable to SEI decreased $26.7 million, or 12 percent, to $205.0 million and diluted earnings per share decreased to $1.11 per share in 2011 compared to $1.22 per share in 2010. We believe the following items were significant to our business during 2011: • Revenue growth was primarily driven by higher Asset management, administration and distribution fees across the business segments from improved capital market conditions. The majority of our asset-based revenues are based upon average assets, which increased during the year despite the sharp decline experienced during the third quarter. Our average assets under management, excluding LSV, increased $9.8 billion, or nine percent, to $117.0 billion during the year as compared to $107.2 billion during 2010.

• New business coupled with asset funding from existing clients for our hedge fund solutions and increased accounts for our separately managed accounts solutions in our Investment Managers segment also served to drive revenue growth.

• Revenues in our Private Banks business segment were negatively impacted by lower investment processing fees from price reductions provided to existing clients that recontracted for longer periods, lower transaction volumes and lower one-time project-related fees. Furthermore, the full impact of previously-announced client losses in the segment were reflected in 2011 as the associated recurring and one-time revenues from the client losses were recognized in the preceding year.

Page 18 of 76--------------------------------------------------------------------------------• Our proportionate share in the earnings of LSV in 2011 was $105.8 million as compared to $99.5 million in 2010, an increase of six percent. The net market appreciation in LSV's average assets under management during the first half of 2011 as well as increased performance fees resulted in an overall increase in their revenues. Although ending assets under management declined to $53.7 billion, LSV's average assets under management increased $5.2 billion, or ten percent, to $58.5 billion during the year as compared to $53.3 billion during the prior year.

• Our operating expenses related to servicing new and existing clients implemented on GWP has increased as we continue to build out the operational infrastructure and add new functionality to the platform. A higher portion of these costs are not capitalized. These increased operational costs primarily impacted the Private Banks and Investment Advisors business segments. The increased operational costs are included in Compensation, benefits and other personnel, Consulting, outsourcing and professional fees, and Data processing and computer related expenses on the accompanying Consolidated Statements of Operations.

• Our operating expenses related to servicing new and existing clients of our hedge fund and separately managed accounts solutions of our Investment Managers business segment increased during the year. These increased operational costs are also included in Compensation, benefits and other personnel, Consulting, outsourcing and professional fees, and Data processing and computer related expenses on the accompanying Consolidated Statements of Operations.

• We recognized $3.4 million in gains from SIV securities in 2011 as compared to $44.2 million in gains in 2010. Of the net gains recognized during 2011, gains of $10.6 million resulted from cash payments received from the SIV securities that had been previously written down offset by losses of $7.2 million which resulted from a decrease in fair value at December 31, 2011.

• Stock-based compensation costs declined in 2011 and reflect the return to normal levels of expense amortization as compared to the level in 2010.

Stock-based compensation costs decreased during the year due to the acceleration of stock-based compensation in 2010 due to a change in management's estimates of the attainment of certain performance vesting targets, net of the reversal of $6.2 million in stock-based compensation costs in the third quarter 2010.

• We continued our stock repurchase program during 2011 and purchased approximately 11,109,000 shares at an average price of $19.01 per share for a total cost of $211.2 million.

• We made principal payments of $95.0 million during 2011, including a final payment of $20.0 million in the fourth quarter, to fully repay the outstanding balance of our credit facility.

• Our effective tax rate in 2011 declined to 35.2 percent from 37.0 percent in 2010. Our tax rate in 2011 was favorably impacted by tax planning strategies implemented during 2011.

Product Development - Global Wealth Platform Much of our product development efforts have been focused on building and delivering GWP. GWP is a business solution heavily supported by technology to drive our entry into the European private bank market, improve client experience capabilities, and strengthen operating efficiencies. GWP combines internally built functionality and third party applications and integrates them into a single solution with a single user experience. The goal is to provide straight through business processing and transform the middle and back office operations that exist today. The capabilities of GWP will expand our service offerings to include large financial institutions, investment advisors, insurance companies, brokerage houses, and other similar institutions. In addition, the capabilities of GWP provide us the opportunity to enter into new global markets.

The initial version of GWP was offered in July 2007 in the United Kingdom. Since then we have signed about 20 independent wealth advisors and other wealth managers in the United Kingdom, converted a small, select group of investment advisors in the United States and implemented our first U.S. bank in late 2012.

We firmly believe these are encouraging signs of progress but acknowledge GWP is still in the early stage of deployment. We will continue to focus our development efforts on enhancing the functionality of GWP and building the operational infrastructure for a wider deployment of GWP to financial institutions and investment advisors in the United States. The aggregate cost attributable to GWP, including amortization expense, may increase in 2013.

An area of continued focus is improving the operational efficiency of GWP that would promote scale more quickly. Our operational costs consist mainly of third-party vendor costs and SEI personnel. We are investing in the operational infrastructure that will attempt to provide a sustainable operating model that minimizes cost as revenues increase. However, if we are unable to price our services correctly and to provide an attractive value proposition for our prospective clients, the incremental rate of revenue and profits may be hampered.

As we progress through these initial stages of deployment of GWP to a broader market, we expect to encounter numerous challenges; however, in our opinion, GWP promises to provide a significant opportunity to expand our services into new markets that will increase revenues and profits in the long-term. Until we attain a level of revenues that technological and operational scale can be achieved, we expect continued pressure on our operating margins in the Private Banks business segment and a modest level of pressure on our operating margins in the Investment Advisors business segment.

Page 19 of 76 -------------------------------------------------------------------------------- Ending Asset Balances This table presents ending asset balances of our clients, or of our clients' customers, for which we provide management or administrative services through our subsidiaries and partnerships in which we have a significant interest.

Ending Asset Balances (In millions) As of December 31, Percent Percent 2012 2011 Change 2010 Change Private Banks: Equity and fixed-income programs $ 18,862 $ 16,435 15 % $ 13,512 22 % Collective trust fund programs 11 450 (98 )% 626 (28 )% Liquidity funds 6,008 5,553 8 % 5,120 8 % Total assets under management $ 24,881 $ 22,438 11 % $ 19,258 17 % Client proprietary assets under administration 12,178 10,355 18 % 10,672 (3 )% Total assets $ 37,059 $ 32,793 13 % $ 29,930 10 % Investment Advisors: Equity and fixed-income programs $ 31,220 $ 26,639 17 % $ 27,680 (4 )% Collective trust fund programs 14 1,298 (99 )% 1,820 (29 )% Liquidity funds 2,514 2,505 - % 1,641 53 % Total assets under management $ 33,748 $ 30,442 11 % $ 31,141 (2 )% Institutional Investors: Equity and fixed-income programs $ 62,160 $ 49,051 27 % $ 48,699 1 % Collective trust fund programs 102 492 (79 )% 623 (21 )% Liquidity funds 2,454 3,888 (37 )% 3,382 15 % Total assets under management $ 64,716 $ 53,431 21 % $ 52,704 1 % Investment Managers: Equity and fixed-income programs $ 67 $ 57 N/A $ 1 N/A Collective trust fund programs 16,197 11,255 44 % 8,177 38 % Liquidity funds 408 152 168 % 313 (51 )% Total assets under management $ 16,672 $ 11,464 45 % $ 8,491 35 % Client proprietary assets under administration 244,671 221,198 11 % 233,079 (5 )% Total assets $ 261,343 $ 232,662 12 % $ 241,570 (4 )% Investments in New Businesses: Equity and fixed-income programs $ 513 $ 515 - % $ 569 (9 )% Liquidity funds 43 37 16 % 65 (43 )% Total assets under management $ 556 $ 552 1 % $ 634 (13 )% LSV: Equity and fixed-income programs $ 60,947 $ 53,712 13 % $ 60,058 (11 )% Total: Equity and fixed-income programs $ 173,769 $ 146,409 19 % $ 150,519 (3 )% Collective trust fund programs 16,324 13,495 21 % 11,246 20 % Liquidity funds 11,427 12,135 (6 )% 10,521 15 % Total assets under management $ 201,520 $ 172,039 17 % $ 172,286 - % Client proprietary assets under administration 256,849 231,553 11 % 243,751 (5 )% Total assets under management and administration $ 458,369 $ 403,592 14 % $ 416,037 (3 )% Page 20 of 76-------------------------------------------------------------------------------- Average Asset Balances This table presents average asset balances of our clients, or of our clients' customers, for which we provide management or administrative services through our subsidiaries and partnerships in which we have a significant interest.

Average Asset Balances (In millions) For the Year Ended December 31, Percent Percent 2012 2011 Change 2010 Change Private Banks: Equity and fixed-income programs $ 17,434 $ 15,891 10 % $ 12,579 26 % Collective trust fund programs 282 526 (46 )% 772 (32 )% Liquidity funds 5,332 5,145 4 % 5,247 (2 )% Total assets under management $ 23,048 $ 21,562 7 % $ 18,598 16 % Client proprietary assets under administration 10,873 10,672 2 % 10,907 (2 )% Total assets $ 33,921 $ 32,234 5 % $ 29,505 9 % Investment Advisors: Equity and fixed-income programs $ 29,611 $ 27,274 9 % $ 25,832 6 %Collective trust fund programs 728 1,497 (51 )% 2,118 (29 )% Liquidity funds 1,970 1,970 - % 1,986 (1 )% Total assets under management $ 32,309 $ 30,741 5 % $ 29,936 3 % Institutional Investors: Equity and fixed-income programs $ 56,584 $ 49,895 13 % $ 45,926 9 % Collective trust fund programs 312 542 (42 )% 649 (16 )% Liquidity funds 3,415 3,453 (1 )% 3,358 3 % Total assets under management $ 60,311 $ 53,890 12 % $ 49,933 8 % Investment Managers: Equity and fixed-income programs $ 63 $ 39 62 % $ 2 N/A Collective trust fund programs 13,873 9,978 39 % 7,687 30 % Liquidity funds 276 199 39 % 467 (57 )% Total assets under management $ 14,212 $ 10,216 39 % $ 8,156 25 % Client proprietary assets under administration 233,024 235,096 (1 )% 225,045 4 % Total assets $ 247,236 $ 245,312 1 % $ 233,201 5 % Investments in New Businesses: Equity and fixed-income programs $ 537 $ 545 (1 )% $ 520 5 % Liquidity funds 35 47 (26 )% 73 (36 )% Total assets under management $ 572 $ 592 (3 )% $ 593 - % LSV: Equity and fixed-income programs $ 57,935 $ 58,478 (1 )% $ 53,345 10 % Total: Equity and fixed-income programs $ 162,164 $ 152,122 7 % $ 138,204 10 % Collective trust fund programs 15,195 12,543 21 % 11,226 12 % Liquidity funds 11,028 10,814 2 % 11,131 (3 )% Total assets under management $ 188,387 $ 175,479 7 % $ 160,561 9 % Client proprietary assets under administration 243,897 245,768 (1 )% 235,952 4 % Total assets under management and administration $ 432,284 $ 421,247 3 % $ 396,513 6 % Page 21 of 76-------------------------------------------------------------------------------- In the preceding tables, assets under management are total assets of our clients or their customers invested in our equity and fixed-income investment programs, collective trust fund programs, and liquidity funds for which we provide asset management services. Assets under management and administration also include total assets of our clients or their customers for which we provide administrative services, including client proprietary fund balances for which we provide administration and/or distribution services. All assets presented in the preceding tables are not included in the accompanying Consolidated Balance Sheets because we do not own them.

Business Segments Revenues, Expenses, and Operating Profit (Loss) for our business segments for the year ended 2012 compared to the year ended 2011, and for the year ended 2011 compared to the year ended 2010 are: Percent Percent Year Ended December 31, 2012 2011 Change 2010 Change Private Banks: Revenues $ 364,788 $ 348,122 5 % $ 346,668 - % Expenses 357,001 339,339 5 % 310,633 9 % Operating Profit $ 7,787 $ 8,783 (11 )% $ 36,035 (76 )% Operating Margin 2 % 3 % 10 % Investment Advisors: Revenues 202,703 189,780 7 % 183,378 3 % Expenses 120,146 110,438 9 % 110,388 - % Operating Profit $ 82,557 $ 79,342 4 % $ 72,990 9 % Operating Margin 41 % 42 % 40 % Institutional Investors: Revenues 227,889 210,027 9 % 206,531 2 % Expenses 116,546 106,585 9 % 106,934 - % Operating Profit $ 111,343 $ 103,442 8 % $ 99,597 4 % Operating Margin 49 % 49 % 48 % Investment Managers: Revenues 193,484 177,975 9 % 160,159 11 % Expenses 127,525 115,963 10 % 103,421 12 % Operating Profit $ 65,959 $ 62,012 6 % $ 56,738 9 % Operating Margin 34 % 35 % 35 % Investments in New Businesses: Revenues 3,658 3,823 (4 )% 4,099 (7 )% Expenses 14,954 11,559 29 % 12,676 (9 )% Operating Loss $ (11,296 ) $ (7,736 ) N/A $ (8,577 ) N/A For additional information pertaining to our business segments, see Note 13 to the Consolidated Financial Statements.

Page 22 of 76 -------------------------------------------------------------------------------- Private Banks Percent Percent Year Ended December 31, 2012 2011 Change 2010 Change Revenues: Investment processing and software servicing fees $ 233,790 $ 220,684 6 % $ 229,247 (4 )% Asset management, administration & distribution fees 103,712 96,531 7 % 87,288 11 % Transaction-based and trade execution fees 27,286 30,907 (12 )% 30,133 3 % Total revenues $ 364,788 $ 348,122 5 % $ 346,668 - % Revenues increased $16.7 million, or five percent, in 2012 compared to the prior year. Revenues during 2012 were primarily affected by: • Increased recurring investment processing fees from new investment processing clients; • Increased one-time project revenue from new and existing bank clients; • Increased fees earned on our mutual fund trading solution due to an increase in assets processed on the system from new and existing clients; • Increased investment management fees from existing international clients due to higher average assets under management from improved capital markets; partially offset by • Lower recurring investment processing fees due to price reductions provided to existing clients that recontracted for longer periods and client losses; as well as • Decreased transaction-based fees due to lower trading volumes across the majority of our bank clients.

Revenues increased slightly in 2011 compared to the prior year. Revenues during 2011 were primarily affected by: • Increased investment management fees from existing international clients due to higher average assets under management from improved capital markets in late 2010 into the first half of 2011, positive cash flows and favorable exchange rates; and • Increased net investment processing fees from new clients implemented onto GWP; partially offset by • Lower recurring investment processing fees due to price reductions provided to existing clients that recontracted for longer periods, lower transaction volumes and client losses occurring in 2010; and • Lower one-time project-related investment processing fees.

Operating margins were two percent in 2012 and three percent in 2011. Operating income decreased $1.0 million, or 11 percent, in 2012 compared to the prior year. Operating income in 2012 was primarily affected by: • Increased amortization expense related to GWP due to continued releases and the discontinuation of specific functionality within the platform resulting in $2.7 million of expense recognized in the third quarter 2012 for the remaining net book value of the component; • Increased direct expenses associated with increased investment management fees from existing international clients; • Increased sales compensation expense due to new business activity and other personnel costs, mainly salary, benefits and incentive compensation; • Increased non-capitalized development costs, mainly personnel costs, relating to GWP; and • Increased operational costs, mainly personnel and third party service provider costs, for servicing new and existing clients implemented onto GWP; partially offset by • An increase in revenues; and • Decreased direct expenses associated with the decreased trade execution fees.

Operating margins were three percent in 2011 and ten percent in 2010. Operating income decreased $27.3 million, or 76 percent, in 2011 compared to the prior year. Operating income in 2011 was primarily affected by: • Increased non-capitalized development costs, mainly consulting fees, and amortization expense relating to GWP; • Increased operational costs, mainly personnel and data processing and computer-related expenses, for servicing new and existing clients implemented onto GWP; and • Increased direct expenses associated with increased investment management fees from existing international clients; partially offset by • Decreased stock-based compensation costs due to the acceleration in 2010, net of the reversal of stock-based compensation costs in the third quarter 2010; • Decreased one-time termination costs associated with a workforce reduction in first quarter 2010; and • An increase in revenues.

Page 23 of 76--------------------------------------------------------------------------------Investment Advisors Revenues increased $12.9 million, or seven percent, in 2012 compared to the prior year. Revenues during 2012 were primarily affected by: • Increased investment management fees from existing clients due to higher average assets under management caused by market appreciation during 2012 and an increase in net cash flows from new and existing advisors in both our mutual fund and managed account solutions, • An increase in the average basis points earned on assets due to the increase in average assets under management; partially offset by • Lower fees earned from our collective trust fund offering due to the closing of the SEI Stable Asset Fund during 2012.

Revenues increased $6.4 million, or three percent, in 2011 compared to the prior year. Revenues during 2011 were primarily affected by: • Increased investment management fees from existing clients due to higher average assets under management caused by improved capital markets during the latter half of 2010 and through the first half of 2011 and an increase in net cash flows in 2011 from new advisors.

Operating margins were 41 percent in 2012 and 42 percent in 2011. Operating income increased $3.2 million, or four percent, in 2012 compared to the prior year. Operating income in 2012 was primarily affected by: • An increase in revenues; • A decrease in direct costs associated with the closing of the SEI Stable Asset Fund; partially offset by • Increased amortization expense relating to GWP as well as spending associated with building the necessary functionality and infrastructure for servicing financial institutions and investment advisors in the United States; and • Increased sales compensation expense due to new business activity and other personnel costs, mainly salary, benefits and incentive compensation.

Operating margins were 42 percent in 2011 and 40 percent in 2010. Operating income increased $6.4 million, or nine percent, in 2011 compared to the prior year. Operating income in 2011 was primarily affected by: • An increase in revenues; • Decreased stock-based compensation costs due to the acceleration in 2010, net of the reversal of stock-based compensation costs in the third quarter 2010; and • A charge of approximately $1.0 million related to a processing error in third quarter 2010; partially offset by • Increased non-capitalized development costs and amortization expense relating to GWP as well as spending associated with building the necessary functionality and infrastructure for servicing financial institutions and investment advisors in the United States; and • Increased compensation and other personnel expenses.

Institutional Investors Revenues increased $17.9 million, or nine percent, in 2012 compared to the prior year. Revenues during 2012 were primarily affected by: • Increased investment management fees from existing clients due to higher average assets under management caused by improved capital markets as well as additional asset funding from existing clients; and • Asset funding from new sales of our retirement and not-for-profit solutions; partially offset by • Client losses and lower basis points earned on assets under management.

Revenues increased $3.5 million, or two percent, in 2011 compared to the prior year. Revenues during 2011 were primarily affected by: • Increased investment management fees from existing clients due to higher average assets under management caused by improved capital markets during the latter half of 2010 and through the first half of 2011 as well as additional asset funding from existing clients; and • Asset funding from new sales of our retirement and not-for-profit solutions; partially offset by client losses.

Operating margins were 49 percent in 2012 and 2011. Operating income increased $7.9 million, or eight percent, in 2012 compared to the prior year. Operating income during 2012 was primarily affected by: • An increase in revenues; partially offset by Page 24 of 76 --------------------------------------------------------------------------------• Increased sales compensation expense due to new business activity and other personnel costs, mainly salary, benefits and incentive compensation; and • Increased direct expenses associated with higher investment management fees.

Operating margins were 49 percent in 2011 and 48 percent in 2010. Operating income increased $3.8 million, or four percent, in 2011 compared to the prior year. Operating income during 2011 was primarily affected by: • An increase in revenues; • Decreased stock-based compensation costs due to the acceleration in 2010, net of the reversal of stock-based compensation costs in the third quarter 2010; and • Decreased discretionary marketing and promotion expenses; partially offset by • Increased compensation and other personnel expenses; and • Increased direct expenses associated with higher investment management fees.

Investment Managers Revenues increased $15.5 million, or nine percent, in 2012 compared to the prior year. Revenues during 2012 were primarily affected by: • Cash flows from new clients of our hedge funds and collective trust fund solutions; • Net positive cash flows from existing hedge fund clients due to new funding along with higher valuations from capital market increases; and • Increased accounts from our separately managed account program due to new clients and existing clients involved in mergers; partially offset by client losses.

Revenues increased $17.8 million, or 11 percent, in 2011 compared to the prior year. Revenues during 2011 were primarily affected by: • Cash flows from new clients of our hedge funds and collective trust fund solutions; • Net positive cash flows from existing hedge fund clients mainly due to higher valuations from capital market increases mostly during the first half of 2011; and • Increased accounts from our separately managed account program due to new clients and existing clients involved in mergers; partially offset by client losses.

Operating margins were 34 percent in 2012 and 35 percent in 2011. Operating income increased $3.9 million, or six percent, in 2012 compared to the prior year. Operating income during 2012 was primarily affected by: • An increase in revenues; partially offset by • Increased personnel expenses and other operational costs to service new clients of our hedge fund and separately managed accounts solutions.

Operating margins were 35 percent in 2011 and 2010. Operating income increased $5.3 million, or nine percent, in 2011 compared to the prior year. Operating income during 2011 was primarily affected by: • An increase in revenues; and • Decreased stock-based compensation costs due to the acceleration in 2010, net of the reversal of stock-based compensation costs in the third quarter 2010; partially offset by • Increased personnel expenses, technology and other operational costs to service new clients of our hedge fund and separately managed accounts solutions.

Other Other Income and Expense Items Other income and expense items on the accompanying Consolidated Statements of Operations consist of: Year Ended December 31, 2012 2011 2010 Net gain from investments $ 14,067 $ 3,360 $ 48,533 Interest and dividend income 5,696 5,829 6,326 Interest expense (504 ) (585 ) (1,478 ) Other expense, net - - (590 ) Equity in earnings of unconsolidated affiliates 98,671 105,818 99,457 Total other income and expense items, net $ 117,930 $ 114,422 $ 152,248 Page 25 of 76-------------------------------------------------------------------------------- Net gain from investments Net gain from investments consists of: Year Ended December 31, 2012 2011 2010 Gains from SIV securities $ 13,240 $ 3,390 $ 44,247 Net realized and unrealized gains (losses) from marketable securities 1,123 (25 ) 1,214 Other (losses) gains (296 ) (5 ) 3,072 Net gain from investments $ 14,067 $ 3,360 $ 48,533 We record our SIV securities at fair value and recognize unrealized gains and losses of the securities in current earnings. During 2012, 2011 and 2010, we recognized net gains from SIV securities of $13.2 million, $3.4 million and $44.2 million, respectively. Of the net gains recognized during 2012, $6.8 million resulted from cash payments received from the SIV securities and $1.1 million was from a net increase in fair value. In November 2012, we sold our remaining SIV security, the Gryphon senior note, and recognized a gain of $5.3 million from the sale. During 2011, we recognized gains from SIV securities of $3.4 million, of which $10.6 million resulted from cash payments received from the SIV securities offset by losses of $7.2 million which resulted from a decrease in fair value at December 31, 2011. Of the net gains recognized during 2010, $27.5 million resulted from cash payments received from SIV securities and $16.5 million resulted from a net increase in the fair value at December 31, 2010. In addition, we recognized a net gain of $0.2 million from sales of three SIV securities during 2010. These gains and losses are included in Gains from SIV securities in the preceding table.

We recognized a $3.1 million gain in 2010 due to the sale of our ownership interest in a small company that was involved in a merger. This gain is reflected in Other (losses) gains in the preceding table.

Equity in earnings of unconsolidated affiliates Equity in earnings of unconsolidated affiliates primarily includes our ownership in LSV. In March 2009, certain partners of LSV, including SEI, agreed to designate a portion of their partnership interest for the purpose of providing an interest in the partnership to a select group of key LSV employees. In April 2012, these contributing partners agreed to provide a partnership interest to the key LSV employees thereby reducing our interest in LSV to approximately 39.8 percent from 41.2 percent.

Our proportionate share in the earnings of LSV was $100.0 million and $105.8 million in 2012 and 2011, respectively. The decrease in 2012 was primarily due to lower profits due to increased operating expenses, mainly related to personnel. LSV revenues were flat in 2012 as compared to 2011. In 2011, our proportionate share in the earnings of LSV increased to $105.8 million from $99.5 million in 2010. The increase in 2011 was also due to improved capital markets and increased performance fees.

Noncontrolling interest Noncontrolling interest includes the interest of other shareholders in our joint venture in SAK, an asset management firm located in South Korea (See the caption "Sale of SEI Asset Korea" later in this discussion for more information).

Income Taxes Our effective tax rate was 36.9 percent in 2012, 35.2 percent in 2011, and 37.0 percent in 2010. The 2012 tax rate was negatively affected by the expiration of the research and development tax credit, which was not reinstated until the signing of the American Taxpayer Relief Act of 2012 into law on January 3, 2013.

The tax credit was reinstated retroactively for 2012; however, accounting guidance requires the determination of current and deferred taxes be based upon enacted tax law as of the balance sheet date. The effect of the 2012 research and development tax credit will be reflected in the first quarter of 2013. The 2012 tax rate was also negatively affected by the accrual of U.S. deferred taxes on the undistributed earnings of SEI AK. As a result of the expected sale of SEI AK, we no longer consider the undistributed earnings of that subsidiary to be indefinitely reinvested and therefore accrued U.S. deferred taxes on the cumulative undistributed earnings (See caption "Sale of SEI Asset Korea" later in this discussion for additional information). This increase of taxes was partially offset by state tax planning. Our tax rate in 2011 was favorably impacted by determination that we were eligible for the Domestic Production Activities Deduction. The effective rate for 2011 reflects the benefit of this deduction for 2007 through 2011. Excluding the benefit for the Domestic Production Activities Deduction, our effective tax rate would be 37.4 percent.

We expect our effective tax rate to be between 35.0 and 36.0 percent in 2013 with the first quarter rate expected to be lower than the remaining quarters.

Stock-Based Compensation During 2012, 2011 and 2010, we recognized approximately $15.7 million, $14.1 million and $26.8 million, respectively, in stock-based compensation expense.

Page 26 of 76 --------------------------------------------------------------------------------Based upon our current view of how many options will vest and when they will vest, we estimate that stock-based compensation expense will be recognized according to the following schedule: Stock-Based Compensation Expense 2013 $ 18,274 2014 17,978 2015 6,708 2016 3,711 2017 3,593 $ 50,264 Fair Value Measurements The fair value of our financial assets and liabilities is determined in accordance with the fair value hierarchy. The fair value of most of our financial assets are determined using Level 1 or Level 2 inputs and consist mainly of investments in equities or mutual funds that are quoted daily and Government National Mortgage Association (GNMA) and other U.S. government agency securities that are single issuer pools that are valued based on current market data of similar assets. Our Level 3 financial assets consisted mainly of SIV securities. As of December 31, 2012, we no longer own any SIV securities. We did not have any financial liabilities at December 31, 2012 or 2011. See Note 5 to the Consolidated Financial Statements for more information pertaining to the valuation of SIV securities.

Sale of SEI Asset Korea On July 31, 2012, SEI, MetLife International Holdings, Inc. (MetLife) and International Finance Corporation (IFC) entered into a definitive agreement with Baring Asset Management Limited to sell all ownership interests in SEI AK. SEI AK is located in South Korea and provides domestic equity and fixed income investment management services to financial institutions and pension funds.

Consummation of the acquisition of SEI AK under the definitive agreement is subject to regulatory approvals and other customary closing conditions.

Our ownership interest in SEI AK is currently 56.1 percent. We consolidate the assets, liabilities and operations of SEI AK in our Consolidated Financial Statements. The ownership interests in SEI AK for MetLife and IFC is reflected in Noncontrolling interest in our Consolidated Financial Statements. The operating results of SEI AK are included in the Private Banks business segment.

Upon closing of the agreement, the then current cash balance of SEI AK will be distributed to SEI, Metlife and IFC in accordance with the ownership interests.

As of December 31, 2012, SEI AK had total corporate assets of $54.8 million, of which $48.3 million is included in Cash and Cash equivalents on the Consolidated Balance Sheet. All other accounts of SEI AK are not material to any financial statement line item in the Consolidated Financial Statements.

We did not provide U.S. deferred taxes on the undistributed earnings of SEI AK since its inception because we considered those earnings to be indefinitely reinvested. As a result of the potential sale of SEI AK, however, we no longer consider the undistributed earnings of SEI AK to be indefinitely reinvested and accrued $4.8 million in U.S. deferred taxes on the cumulative undistributed earnings during 2012.

If the requisite regulatory approvals are obtained, the other conditions to closing are satisfied or waived and the transaction is consummated, we expect the net after tax gain on the sale of our shares of SEI AK to range from approximately $8.9 million to $20.6 million depending upon revenue during a pre-closing measurement period and specified revenues during three one-year periods after the closing. We expect the closing of the transaction to occur by the end of the first quarter 2013.

Regulatory Matters Like many firms operating within the financial services industry, we are experiencing a difficult regulatory environment across our markets. Our current scale and reach as a provider to the financial services industry; the introduction and implementation of new solutions for our financial services industry clients; the increased regulatory oversight of the financial services industry generally; new laws and regulations affecting the financial services industry and ever-changing regulatory interpretations of existing laws and regulations; and a greater propensity of regulators to pursue enforcement actions and other sanctions against regulated entities, have made this an increasingly challenging and costly regulatory environment in which to operate.

During the last twelve months, SEI and some of our regulated subsidiaries have undergone or been scheduled to undergo a range of periodic or thematic reviews or examinations by more than eight regulatory authorities around the world, including the Page 27 of 76 -------------------------------------------------------------------------------- Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Securities and Exchange Commission, the Financial Industry Regulatory Authority, the Financial Services Authority of the United Kingdom, the Central Bank of Ireland and others. In a number of instances, these are the first recurring examinations by these regulatory authorities. These examinations typically result in the identification of matters or practices to be addressed by us or our subsidiaries and, in certain circumstances, the regulatory authorities could require remediation activities or pursue enforcement proceedings against us or our subsidiaries. As described under the caption "Regulatory Considerations" in Item 1 of this report, the range of possible sanctions that are available to regulatory authorities include limitations on our ability to engage in business for specified periods of time, the revocation of registration, censures and fines. The direct and indirect costs of responding to these examinations and reviews and of complying with new or modified regulations, as well as the potential financial costs and potential reputational impact against us of any enforcement proceedings that might result, is uncertain but could have a material adverse impact on our operating results or financial position.

Liquidity and Capital Resources Year Ended December 31, 2012 2011 2010 Net cash provided by operating activities $ 257,490 $ 256,962 $ 229,326 Net cash provided by (used in) investing activities 16,627 (31,950 ) (41,475 ) Net cash used in financing activities (242,856 ) (300,318 ) (282,436 ) Net increase (decrease) in cash and cash equivalents 31,261 (75,306 ) (94,585 ) Cash and cash equivalents, beginning of year 420,986 496,292 590,877 Cash and cash equivalents, end of year $ 452,247 $ 420,986 $ 496,292 Cash requirements and liquidity needs are primarily funded through our cash flow from operations and our capacity for additional borrowing. At December 31, 2012, our unused sources of liquidity consisted of cash and cash equivalents and the full amount available under the existing credit facility which does not expire until February 2017.

In February 2012, we replaced our previous credit facility with a new five-year credit facility agreement which provides for borrowings of up to $300.0 million.

The new credit facility is a senior unsecured revolving line of credit with Wells Fargo Bank, National Association, and a syndicate of other lenders and is scheduled to expire in February 2017. The availability of the new credit facility is subject to compliance with certain covenants set forth in the agreement. The credit facility contains covenants which restrict our ability to engage in mergers, consolidations, asset sales, investments, transactions with affiliates, or to incur liens, as defined in the agreement. In the event of a default under the credit facility, we would also be restricted from paying dividends on, or repurchasing, our common stock. Currently, our ability to borrow from the credit facility is not limited by any covenant of the agreement.

We currently have no borrowings under the new credit facility.

The majority of our excess cash reserves are primarily placed in accounts located in the United States that invest entirely in SEI-sponsored money market mutual funds denominated in the U.S. dollar. We also utilize demand deposit accounts or money market accounts at several well-established financial institutions located in the United States. Accounts used to manage these excess cash reserves do not impose any restrictions or limitations that would prevent us from being able to access such cash amounts immediately. As of January 31, 2013, the amount of cash and cash equivalents considered free and immediately accessible for other general corporate purposes was $245.9 million.

Our cash and cash equivalents include accounts managed by our subsidiaries and minority-owned subsidiaries that are used in their operations or to cover specific business and regulatory requirements. The availability of this cash for other purposes beyond the operations of these subsidiaries may be limited. Also, some of our foreign subsidiaries may have excess cash reserves which are considered to be undistributed earnings and indefinitely reinvested. Upon distribution of these earnings, in the form of dividends or otherwise, we would be immediately subject to both U.S. and foreign withholding taxes which would reduce the amount we would ultimately realize. We do not include accounts of our foreign subsidiaries in our calculation of free and immediately accessible cash for other general corporate purposes.

Cash flows from operations increased $0.5 million in 2012 compared to 2011 primarily due to an increase in our earnings. The net change in our working capital accounts is mostly impacted by changes in our receivables balances. The increase in our receivables is largely due to our growth in revenues in our asset management business and an increased proportion of our receivables related to investment operations services which provide for comparatively longer billing schedules due to longer processes in valuing the underlying securities upon which the billings are based. We do not foresee any significant collectibility issues regarding receivables and have not received any indications that we should anticipate any significant collectibility issues in the near term.

Cash flows from operations increased $27.6 million in 2011 compared to 2010 due to the partnership distribution payments received from LSV, non-cash adjustments for net realized gains from marketable securities in 2011 as opposed to 2010, and the net change in our working capital accounts.

Page 28 of 76 -------------------------------------------------------------------------------- Cash flows from investing activities increased $48.6 million in 2012 compared to 2011 primarily due to the sale of the Gryphon notes and reduced purchases of marketable securities. Net cash used in investing activities includes: • Purchases, sales and maturities of marketable securities. We had cash outflows of $33.7 million for the purchase of marketable securities in 2012 as compared to $74.0 million in 2011. Marketable securities purchased in 2012 primarily consisted of investments in short-term U.S. government agency and commercial paper securities through SIDCO's cash management program and investments for the start-up of new investment products.

Marketable securities purchased in 2011 consisted of investments in short-term U.S. government agency and commercial paper securities by SIDCO, additional GNMA securities to satisfy applicable regulatory requirements of SPTC and investments for the start-up of new investment products. We had cash inflows of $108.2 million from sales and maturities of marketable securities, including principal prepayments received from our GNMA and SIV securities, in 2012 as compared to $99.8 million in 2011. Marketable securities sold in 2012 and 2011 primarily include the proceeds from the sales of SIV securities.

• The capitalization of costs incurred in developing computer software. We will continue the development of GWP through a series of releases to expand the functionality of the platform. We capitalized $31.0 million of software development costs in 2012 as compared to $41.0 million in 2011. Amounts capitalized in 2012 and 2011 include costs for significant enhancements and upgrades to the platform.

• Capital expenditures. Our capital expenditures in 2012 and 2011 primarily include purchased software and equipment for our data center operations.

Cash flows from financing activities decreased $57.5 million in 2012 compared to 2011. Net cash used in financing activities includes: • The repurchase of our common stock. Our Board of Directors has authorized the repurchase of our common stock through multiple authorizations.

Currently, there is no expiration date for our common stock repurchase program. The following table lists information regarding repurchases of our common stock during 2012, 2011, and 2010: Average Price Total Number of Paid Year Shares Repurchased per Share Total Cost 2012 7,528,000 $ 20.62 $ 155,264 2011 11,109,000 19.01 211,165 2010 5,814,000 20.81 120,982 • Principal payments of our debt. Principal payments in 2011 include payments of $95.0 million to repay the remaining balance of our former credit facility. We fully repaid our former credit facility with the final payment of $20.0 million made in December 2011 and had no debt outstanding during 2012 (See Note 7).

• Dividend payments. Our Board of Directors declared a semi-annual cash dividend of $0.16 per share as well as a one-time, special cash dividend of $0.32 per share on December 11, 2012. The semi-annual and special dividends were paid on December 28, 2012 for a total of $82.7 million. The following table lists information regarding cash dividends paid during 2012, 2011, and 2010: Cash Dividends Paid Year Cash Dividends Paid per Share 2012 $ 135,335 $ 0.78 2011 22,041 0.12 2010 54,634 0.29 The increase in dividends paid in 2012 was due to the special dividend in 2012 and the payment date of the regular semi-annual dividend declared in December 2012 occurring in the calendar year as compared to the payment date of the semi-annual dividend declared in December 2011 which occurred in January of 2012.

We believe our operating cash flow, available borrowing capacity, and existing cash and cash equivalents should provide adequate funds for ongoing operations; continued investment in new products and equipment; our common stock repurchase program and future dividend payments.

Significant Arrangement On October 1, 2012, we provided an unsecured guaranty of the obligations of LSV Employee Group III to The PrivateBank and Trust Company and certain other lenders. We entered into this agreement in order to facilitate the acquisition of certain partnership interests of LSV by LSV Employee Group III. Additional information pertaining to the agreement is presented in Note 2 to the Consolidated Financial Statements.

Page 29 of 76 --------------------------------------------------------------------------------Contractual Obligations and Contingent Obligations As of December 31, 2012, the Company is obligated to make payments in connection with its lines of credit, operating leases, maintenance contracts and other commitments in the amounts listed below. The Company has no unrecorded obligations other than the items noted in the following table: 2017 and Total 2013 2014 2015 to 2016 thereafter Line of credit (a) $ 1,862 $ 456 $ 456 $ 912 $ 38 Operating leases and maintenance agreements (b) 35,591 15,138 6,283 4,977 9,193 Other commitments (c) 5,291 5,291 - - - Total $ 42,744 $ 20,885 $ 6,739 $ 5,889 $ 9,231 (a) Amounts include estimated commitment fees for our credit facility. See Note 7 to the Consolidated Financial Statements.

(b) See Note 11 to the Consolidated Financial Statements.

(c) Amount includes the portion of uncertain tax liabilities classified as a current liability. The actual cash payment associated with these commitments may differ. See Note 12 to the Consolidated Financial Statements.

Critical Accounting Policies The accompanying consolidated financial statements and supplementary information were prepared in accordance with accounting principles generally accepted in the United States. Our significant accounting policies are discussed in Note 1 to the Consolidated Financial Statements. Inherent in the application of many of these accounting policies is the need for management to make estimates and judgments in the determination of certain revenues, expenses, assets and liabilities. Materially different financial results can occur as circumstances change and additional information becomes known. We believe that the following accounting policies require extensive judgment by our management to determine the recognition and timing of amounts recorded in our financial statements.

Revenue Recognition: Revenues are recognized in the periods in which the related services are performed provided that persuasive evidence of an agreement exists, the fee is fixed or determinable, and collectibility is reasonably assured. Cash received by us in advance of the performance of services is deferred and recognized as revenue when earned. Our principal sources of revenues are: (1) asset management, administration and distribution fees calculated as a percentage of the total average daily net assets under management or administration; (2) information processing and software servicing fees that are recurring in nature and earned based upon the number of trust accounts being serviced and non-recurring project fees that are earned based upon contractual agreements related to client implementations; and (3) transaction-based fees for providing trade-execution services. Our revenues are based on contractual arrangements.

Certain portions of our revenues require management's consideration of the nature of the client relationship in determining whether to recognize as revenue the gross amount billed or net amount retained after payments are made to vendors for certain services related to the product or service offering.

Fair Value of Financial Assets and Liabilities: We determine the fair value of our financial assets and liabilities in accordance with the fair value hierarchy. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The accounting standard also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The fair value hierarchy describes three levels of inputs that may be used to measure fair value: Level 1 - Quoted prices in active markets for identical assets and liabilities without adjustment; Level 2 - Observable inputs other than Level 1 prices, such as quoted prices for similar assets, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data; and Level 3 - Unobservable inputs that are supported by little or no market activity and are significant to the fair value of those assets or liabilities.

The use of Level 3 inputs to determine the fair value of our financial assets requires considerable judgment by management. Our Level 3 financial assets primarily consisted of SIV securities we owned. As of December 31, 2012, we no longer own any SIV securities. We did not have any financial liabilities at December 31, 2012 or 2011 (See Fair Value Measurements section earlier in this discussion).

Page 30 of 76 -------------------------------------------------------------------------------- We review our investments in marketable securities on a quarterly basis with regard to impairment. Some of the factors considered in determining other-than-temporary impairment for our equity securities include, but are not limited to, significant or prolonged declines in the fair value of our investments, our ability and intent to retain the investment for a period sufficient to allow the value to recover, and the financial condition of the investment. Some of the factors considered in determining other-than-temporary impairment for our debt securities include, but are not limited to, our intent to sell the security, the likelihood that we will be required to sell the security before recovering its cost, and our expectation to recover the entire amortized cost basis of the security even if we do not intend to sell the security. After considering these factors, if we believe that a decline is other-than-temporary, the carrying value of the investment is written down to its fair value through current period earnings.

Computer Software Development Costs: We utilize internally developed computer software as part of our product offering. In the development of a new software product, substantial consideration must be given by management to determine whether costs incurred are research and development costs, or internal software development costs eligible for capitalization. Management must consider a number of different factors during their evaluation of each computer software development project that includes estimates and assumptions. Costs considered to be research and development are expensed as incurred. After meeting specific requirements, internal software development costs are capitalized as incurred. The capitalization and ongoing assessment of recoverability of software development costs requires considerable judgment by management with respect to certain external factors, including, but not limited to, technological and economic feasibility, and estimated economic life. Amortization of capitalized software development costs begins when the product is ready for its intended use.

Capitalized software development costs are amortized on a product-by-product basis using the straight-line method over the estimated economic life of the product or enhancement.

We evaluate the carrying value of our capitalized software when circumstances indicate the carrying value may not be recoverable. The review of capitalized software for impairment requires significant assumptions about operating strategies, underlying technologies utilized, and external market factors. Our capitalized software was developed using mainstream technologies that are industry standards and are based on technology developed by multiple vendors that are significant industry leaders. External market factors include, but are not limited to, expected levels of competition, barriers to entry by potential competitors, stability in the target market and governmental regulations. In 2012, we determined that no events or change in circumstances had occurred that would indicate that our capitalized software development costs were impaired (See Note 1 to the Consolidated Financial Statements).

Income Tax Accounting: We use the asset and liability method of accounting for income taxes. Under this method, income tax expense is recognized for the amount of taxes payable or refundable for the current year. In addition, deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating losses and tax credit carryforwards. Management must make assumptions, judgments and estimates to determine our current provision for income taxes and also our deferred tax assets and liabilities and any valuation allowance to be recorded against a deferred tax asset.

Our assumptions, judgments and estimates relative to the current provision for income taxes take into account current tax laws, our interpretation of current tax laws and possible outcomes of current and future audits conducted by foreign and domestic tax authorities. We have established reserves for income taxes to address potential exposures involving tax positions that could be challenged by tax authorities. Although we believe our assumptions, judgments and estimates are reasonable, changes in tax laws or our interpretation of tax laws and the resolution of any future tax audits could significantly impact the amounts provided for income taxes in our consolidated financial statements.

Our assumptions, judgments and estimates relative to the value of a deferred tax asset take into account predictions of the amount and category of future taxable income, such as income from operations or capital gains income. Actual operating results and the underlying amount and category of income in future years could render our current assumptions, judgments and estimates of recoverable net deferred taxes inaccurate. Any of the assumptions, judgments and estimates mentioned above could cause our actual income tax obligations to differ from our estimates, thus materially impacting our financial position and results of operations.

Stock-Based Compensation: Stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the requisite service period, which is the vesting period. We currently use the Black-Scholes option pricing model to determine the fair value of stock options. The determination of the fair value of stock-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as various other assumptions. These assumptions include our expected stock price volatility over the term of the awards, actual and projected employee stock option exercise Page 31 of 76-------------------------------------------------------------------------------- behaviors, risk-free interest rate and expected dividends. We are required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. The amount of stock-based compensation expense that is recognized in a given period is dependent upon management's estimate of when the earnings per share targets are expected to be achieved. If this estimate proves to be inaccurate, the remaining amount of stock-based compensation expense could be accelerated, spread out over a longer period, or reversed. We currently base our expectations for these assumptions from historical data and other applicable factors. These expectations are subject to change in future periods.

The assessment of critical accounting policies is not meant to be an all-inclusive discussion of the uncertainties to financial results that can occur from the application of the full range of our accounting policies.

Materially different financial results could occur in the application of other accounting policies as well. Also, materially different results can occur upon the adoption of new accounting standards.

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