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

[February 27, 2014]

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 share and per-share data) This discussion reviews and analyzes the consolidated financial condition at December 31, 2013 and 2012, the consolidated results of operations for the years ended December 31, 2013, 2012 and 2011, 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, 2013, through our subsidiaries and partnerships in which we have a significant interest, we manage or administer $559.2 billion in mutual fund and pooled or separately managed assets, including $231.9 billion in assets under management and $327.3 billion in client assets under administration.

Our Condensed Consolidated Statements of Operations for the years ended 2013, 2012 and 2011 were: Percent Percent Year Ended December 31, 2013 2012 Change 2011 Change Revenues $ 1,126,132 $ 992,522 13 % $ 929,727 7 % Expenses 877,723 780,956 12 % 725,662 8 % Income from operations 248,409 211,566 17 % 204,065 4 % Net gain from investments 659 14,067 (95 )% 3,360 NM Interest income, net of interest expense 2,713 5,192 (48 )% 5,244 (1 )% Equity in earnings of unconsolidated affiliates 118,076 98,671 20 % 105,818 (7 )% Gain on sale of subsidiary 22,112 - NM - - % Other income 43,429 - NM - - % Income before income taxes 435,398 329,496 32 % 318,487 3 % Income taxes 146,924 121,462 21 % 111,837 9 % Net income 288,474 208,034 39 % 206,650 1 % Less: Net income attributable to the noncontrolling interest (350 ) (1,186 ) (70 )% (1,691 ) (30 )% Net income attributable to SEI Investments Company $ 288,124 $ 206,848 39 % $ 204,959 1 % Diluted earnings per common share $ 1.64 $ 1.18 39 % $ 1.11 6 % Significant Items Impacting Our Financial Results in 2013 Revenues increased $133.6 million, or 13 percent, to $1.1 billion in 2013 compared to 2012. Net income attributable to SEI increased $81.3 million, or 39 percent, to $288.1 million and diluted earnings per share increased to $1.64 per share in 2013 compared to $1.18 per share in 2012. We believe the following items were significant to our business results during 2013: • Revenue growth was primarily driven by higher Asset management, administration and distribution fees from positive cash flows from new and existing clients and market appreciation. Our average assets under management, excluding LSV, increased $14.9 billion, or 11 percent, to $145.4 billion during 2013 as compared to $130.5 billion during 2012.

Page 17 of 76--------------------------------------------------------------------------------• 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.

• Revenue growth was also driven by increased Information processing and software servicing fees in our Private Banks segment. The increase was primarily attributable to new business and increased fees earned from our mutual fund trading solution.

• We recorded income of $43.4 million, or $0.16 diluted earnings per share, from a cash settlement payment received during the second quarter pertaining to litigation related to the purchase of securities of Cheyne Finance LLC, a structured investment vehicle (SIV) security (See Note 16 to the Consolidated Financial Statements for more information).

• Our proportionate share in the earnings of LSV was $119.0 million in 2013 as compared to $100.0 million in 2012, an increase of 19 percent. The increase in our earnings was primarily driven by the increase in assets under management of LSV from existing clients due to market appreciation and an increase in performance fees earned by LSV. Our earnings from LSV; however, were negatively impacted by the decrease in our ownership interest from approximately 39.8 percent to approximately 39.3 percent during the second quarter. The reduction in our ownership interest is described in greater detail under the caption "Equity in earnings of unconsolidated affiliates" later in this discussion.

• Our sale of SEI Asset Korea (SEI AK) was completed during the first quarter resulting in a gain of $22.1 million, or $0.08 diluted earnings per share.

The gain from the sale is included in Gain on sale of subsidiary on the accompanying Consolidated Statement of Operations. The operating results of SEI AK were included in the Private Banks business segment (See Note 15 to the Consolidated Financial Statements for more information).

• The direct costs associated with our investment management programs increased in our Private Banks and Institutional Investors segments. These costs primarily relate to fees charged by investment advisory firms and are included in Sub-advisory, distribution and other asset management costs on the accompanying Consolidated Statements of Operations.

• Our operating expenses related to personnel and third-party service providers in our Private Banks and Investment Managers segments increased.

These increased operational costs are mainly related to servicing new and existing clients and are included in Compensation, benefits and other personnel as well as Consulting, outsourcing and professional fees on the accompanying Consolidated Statements of Operations.

• Stock-based compensation expense increased by $22.1 million during 2013 as compared 2012 due mainly to a change in our estimate of the timing of when stock option vesting targets will be achieved. The change in our estimate resulted from the positive earnings impacts from the previously mentioned cash payment for the litigation settlement and the sale of SEI AK during 2013 (See the caption "Stock-Based Compensation" later in this discussion for more information).

• We capitalized $39.5 million in 2013 for significant enhancements and new functionality for the SEI Wealth Platform as compared to $31.0 million in 2012. Included in the amount for 2013 is a one-time contractual payment of $8.8 million to exercise a conversion option in lieu of periodic fee payments pertaining to a software license for the Platform. Amortization expense related to capitalized software increased to $34.4 million during 2013 as compared to $32.6 million during 2012 primarily due to continued releases of the Platform. Amortization expense during 2012 includes $2.7 million of expense related to the remaining net book value of a component of the Platform that was discontinued.

• Corporate overhead costs increased due to increased stock-based compensation, increased personnel costs and higher costs related to regulatory and compliance matters.

• Our effective tax rates were 33.7 percent in 2013 and 36.9 percent in 2012.

The 2013 tax rate was benefited by the changes to the Pennsylvania Tax Law primarily relating to the method of apportioning income to Pennsylvania.

These changes have dramatically reduced the deferred tax liability which had accumulated during prior years. Our 2013 tax rate was also benefited by the reinstatement of the research and development tax credit. The 2012 tax rate included the U.S. deferred taxes on the undistributed earnings of SEI AK (See the caption "Income Taxes" later in this discussion for more information).

• We continued our stock repurchase program and purchased approximately 6,789,000 shares at an average price of $30.92 per share for a total cost of $209.9 million.

Page 18 of 76-------------------------------------------------------------------------------- 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.

• 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 the Platform 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 the Platform, 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 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 the Platform. 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 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 AK as well as the impact of the Domestic Production Activities Deduction which benefited our tax rate in 2011.

• We continued our stock repurchase program 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.

Product Development - SEI Wealth Platform Much of our product development efforts have been focused on building and delivering the SEI Wealth Platform. The Platform 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. The Platform 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 the Platform will expand our service offerings to include large financial institutions, investment advisors, insurance companies, Page 19 of 76 -------------------------------------------------------------------------------- brokerage houses, and other similar institutions. In addition, the capabilities of the Platform provide us the opportunity to enter into new global markets.

The initial version of the Platform was offered in July 2007 in the United Kingdom. Since then, we have signed 20 independent wealth advisors and other wealth managers in the United Kingdom and signed 9 banks in the United States.

We have also converted a small, select group of investment advisors in the United States. While these are encouraging signs of progress, we acknowledge the Platform is still in the early stage of deployment. We will continue to focus our development efforts on enhancing the functionality of the Platform and building the operational infrastructure for a wider deployment of the Platform to financial institutions and investment advisors in the United States. The aggregate cost attributable to the Platform, including amortization expense, may increase in 2014.

An area of continued focus is improving the operational efficiency of the Platform 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 different stages of deployment of the Platform to a broader market, we expect to encounter numerous challenges; however, in our opinion, the Platform 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 an increased level of pressure on our operating margins in the Investment Advisors business segment.

Sensitivity of our revenues and earnings to capital market fluctuations The majority of our revenues are based on the value of assets invested in investment products that we manage or administer which are affected by changes in the capital markets. The prevailing capital market conditions during 2013 had a net positive impact on our asset-based investment management fees thereby increasing our base revenues. Conversely, prolonged future downturns in the general capital markets could have adverse affects on our revenues and earnings derived from assets under management and administration.

Page 20 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, 2013 2012 Percent Change 2011 Percent Change Private Banks: Equity and fixed income programs (a) $ 15,472 $ 18,862 (18 )% $ 16,435 15 % Collective trust fund programs 14 11 27 % 450 (98 )% Liquidity funds 5,685 6,008 (5 )% 5,553 8 % Total assets under management $ 21,171 $ 24,881 (15 )% $ 22,438 11 % Client proprietary assets under administration 15,272 12,178 25 % 10,355 18 % Total assets $ 36,443 $ 37,059 (2 )% $ 32,793 13 % Investment Advisors: Equity and fixed income programs $ 38,574 $ 31,220 24 % $ 26,639 17 % Collective trust fund programs 11 14 (21 )% 1,298 (99 )% Liquidity funds 2,846 2,514 13 % 2,505 - % Total assets under management $ 41,431 $ 33,748 23 % $ 30,442 11 % Institutional Investors: Equity and fixed income programs $ 66,548 $ 62,160 7 % $ 49,051 27 % Collective trust fund programs 109 102 7 % 492 (79 )% Liquidity funds 2,644 2,454 8 % 3,888 (37 )% Total assets under management $ 69,301 $ 64,716 7 % $ 53,431 21 % Investment Managers: Equity and fixed income programs $ 69 $ 67 3 % $ 57 18 % Collective trust fund programs 22,377 16,197 38 % 11,255 44 % Liquidity funds 718 408 76 % 152 168 % Total assets under management $ 23,164 $ 16,672 39 % $ 11,464 45 % Client proprietary assets under administration 311,992 244,671 28 % 221,198 11 % Total assets $ 335,156 $ 261,343 28 % $ 232,662 12 % Investments in New Businesses: Equity and fixed income programs $ 619 $ 513 21 % $ 515 - % Liquidity funds 46 43 7 % 37 16 % Total assets under management $ 665 $ 556 20 % $ 552 1 % LSV: Equity and fixed income programs $ 76,189 $ 60,947 25 % $ 53,712 13 % Total: Equity and fixed income programs (a) $ 197,471 $ 173,769 14 % $ 146,409 19 % Collective trust fund programs 22,511 16,324 38 % 13,495 21 % Liquidity funds 11,939 11,427 4 % 12,135 (6 )% Total assets under management $ 231,921 $ 201,520 15 % $ 172,039 17 % Client proprietary assets under administration 327,264 256,849 27 % 231,553 11 % Total assets under management and administration $ 559,185 $ 458,369 22 % $ 403,592 14 % (a) Equity and fixed income programs in the Private Banks segment in 2012 and 2011 includes $7.0 billion and $6.7 billion, respectively, in assets related to SEI AK which was sold in the first quarter of 2013 (See Note 15 to the Consolidated Financial Statements).

Page 21 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, 2013 2012 Percent Change 2011 Percent Change Private Banks: Equity and fixed income programs (a) $ 15,188 $ 17,434 (13 )% $ 15,891 10 % Collective trust fund programs 11 282 (96 )% 526 (46 )% Liquidity funds 5,252 5,332 (2 )% 5,145 4 % Total assets under management $ 20,451 $ 23,048 (11 )% $ 21,562 7 % Client proprietary assets under administration 13,626 10,873 25 % 10,672 2 % Total assets $ 34,077 $ 33,921 - % $ 32,234 5 % Investment Advisors: Equity and fixed income programs $ 35,290 $ 29,611 19 % $ 27,274 9 % Collective trust fund programs 14 728 (98 )% 1,497 (51 )% Liquidity funds 2,355 1,970 20 % 1,970 - % Total assets under management $ 37,659 $ 32,309 17 % $ 30,741 5 % Institutional Investors: Equity and fixed income programs $ 64,003 $ 56,584 13 % $ 49,895 13 % Collective trust fund programs 106 312 (66 )% 542 (42 )% Liquidity funds 2,937 3,415 (14 )% 3,453 (1 )% Total assets under management $ 67,046 $ 60,311 11 % $ 53,890 12 % Investment Managers: Equity and fixed income programs $ 74 $ 63 17 % $ 39 62 % Collective trust fund programs 18,985 13,873 37 % 9,978 39 % Liquidity funds 554 276 101 % 199 39 % Total assets under management $ 19,613 $ 14,212 38 % $ 10,216 39 % Client proprietary assets under administration 286,208 233,024 23 % 235,096 (1 )% Total assets $ 305,821 $ 247,236 24 % $ 245,312 1 % Investments in New Businesses: Equity and fixed income programs $ 577 $ 537 7 % $ 545 (1 )% Liquidity funds 33 35 (6 )% 47 (26 )% Total assets under management $ 610 $ 572 7 % $ 592 (3 )% LSV: Equity and fixed income programs $ 68,870 $ 57,935 19 % $ 58,478 (1 )% Total: Equity and fixed income programs (a) $ 184,002 $ 162,164 13 % $ 152,122 7 % Collective trust fund programs 19,116 15,195 26 % 12,543 21 % Liquidity funds 11,131 11,028 1 % 10,814 2 % Total assets under management $ 214,249 $ 188,387 14 % $ 175,479 7 % Client proprietary assets under administration 299,834 243,897 23 % 245,768 (1 )% Total assets under management and administration $ 514,083 $ 432,284 19 % $ 421,247 3 % (a) Equity and fixed income programs in the Private Banks segment in 2012 and 2011 includes $6.6 billion and $6.0 billion, respectively, in average assets related to SEI AK which was sold in the first quarter of 2013 (See Note 15 to the Consolidated Financial Statements).

Page 22 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 2013 compared to the year ended 2012, and for the year ended 2012 compared to the year ended 2011 are: Percent Percent Year Ended December 31, 2013 2012 Change 2011 Change Private Banks: Revenues $ 397,138 $ 364,788 9 % $ 348,122 5 % Expenses 392,399 357,001 10 % 339,339 5 % Operating profit $ 4,739 $ 7,787 (39 )% $ 8,783 (11 )% Gain on sale of subsidiary 22,112 - NM - - % Total profit $ 26,851 $ 7,787 NM $ 8,783 (11 )% Operating margin (a) 1 % 2 % 3 % Investment Advisors: Revenues 241,252 202,703 19 % 189,780 7 % Expenses 133,962 120,146 11 % 110,438 9 % Operating profit $ 107,290 $ 82,557 30 % $ 79,342 4 % Operating margin 44 % 41 % 42 % Institutional Investors: Revenues 257,658 227,889 13 % 210,027 9 % Expenses 133,218 116,546 14 % 106,585 9 % Operating profit $ 124,440 $ 111,343 12 % $ 103,442 8 % Operating margin 48 % 49 % 49 % Investment Managers: Revenues 226,081 193,484 17 % 177,975 9 % Expenses 148,977 127,525 17 % 115,963 10 % Operating profit $ 77,104 $ 65,959 17 % $ 62,012 6 % Operating margin 34 % 34 % 35 % Investments in New Businesses: Revenues 4,003 3,658 9 % 3,823 (4 )% Expenses 15,723 14,954 5 % 11,559 29 % Operating loss $ (11,720 ) $ (11,296 ) NM $ (7,736 ) NM (a) Percentage for 2013 determined exclusive of gain from sale of subsidiary (See Note 15 to the Consolidated Financial Statements).

For additional information pertaining to our business segments, see Note 13 to the Consolidated Financial Statements.

Page 23 of 76 -------------------------------------------------------------------------------- Private Banks Percent Percent Year Ended December 31, 2013 2012 Change 2011 Change Revenues: Investment processing and software servicing fees $ 260,085 $ 233,790 11 % $ 220,684 6 % Asset management, administration & distribution fees 108,792 103,712 5 % 96,531 7 % Transaction-based and trade execution fees 28,261 27,286 4 % 30,907 (12 )% Total revenues $ 397,138 $ 364,788 9 % $ 348,122 5 % Revenues increased $32.4 million, or nine percent, in 2013 compared to the prior year. Revenues during 2013 were primarily affected by: • Increased recurring investment processing fees from new and existing investment processing clients; • Increased fees earned on our mutual fund trading solution due to an increase in assets from new and existing clients; and • Increased investment management fees from existing clients due to higher average assets under management from improved capital markets, net of the decrease in assets under management from the sale of SEI AK in the first quarter 2013; partially offset by • Lower recurring investment processing fees due to price reductions provided to existing clients that recontracted for longer periods and client losses.

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 from new and existing clients; and • Increased investment management fees from existing 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.

Operating margins were one percent in 2013 and two percent in 2012. Operating income decreased $3.0 million, or 39 percent, in 2013 compared to the prior year. Operating income in 2013 was primarily affected by: • Increased direct expenses associated with the increased investment management fees from existing international clients and our mutual fund trading solution; • Increased operational costs, mainly salary, incentive compensation, consulting and outsourcing costs, for servicing new and existing investment processing clients; • Increased stock-based compensation costs of $6.3 million primarily due to the change in management's estimate of the timing of the achievement of stock option vesting targets; • Increased direct expenses associated with the increased investment processing fees; and • Increased amortization expense related to the SEI Wealth Platform due to continued releases; partially offset by • An increase in revenues.

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 the SEI Wealth Platform due to continued releases and the discontinuation of specific functionality 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 the SEI Wealth Platform; and Page 24 of 76--------------------------------------------------------------------------------• Increased operational costs, mainly personnel and third party service provider costs, for servicing new and existing clients implemented onto the SEI Wealth Platform; partially offset by • An increase in revenues; and • Decreased direct expenses associated with the decreased trade execution fees.

Investment Advisors Revenues increased $38.5 million, or 19 percent, in 2013 compared to the prior year. Revenues during 2013 were primarily affected by: • Increased investment management fees from new and existing clients due to higher average assets under management from market appreciation and positive net cash flows; and • 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 at the end of 2012.

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 from market appreciation and an increase in net cash flows from new and existing advisors in both our mutual fund and managed account solutions; and • 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.

Operating margins were 44 percent in 2013 and 41 percent in 2012. Operating income increased $24.7 million, or 30 percent, in 2013 compared to the prior year. Operating income in 2013 was primarily affected by: • An increase in revenues; partially offset by • Increased amortization expense relating to the SEI Wealth Platform as well as spending associated with building the necessary functionality and infrastructure for servicing financial institutions and investment advisors in the United States; • Increased personnel costs, mainly salary and incentive compensation; and • Increased stock-based compensation costs of $3.9 million primarily due to the change in management's estimate of the timing of the achievement of stock option vesting targets.

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 the SEI Wealth Platform 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.

Institutional Investors Revenues increased $29.8 million, or 13 percent, in 2013 compared to the prior year. Revenues during 2013 were primarily affected by: • Increased investment management fees from existing clients due to higher average assets under management from market appreciation 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.

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 Page 25 of 76--------------------------------------------------------------------------------• Client losses and lower basis points earned on assets under management.

Operating margin were 48 percent in 2013 and 49 percent in 2012. Operating income increased $13.1 million, or 12 percent, in 2013 compared to the prior year. Operating income during 2013 was primarily affected by: • An increase in revenues; partially offset by • Increased direct expenses associated with higher investment management fees; • Increased stock-based compensation costs of $3.7 million primarily due to the change in management's estimate of the timing of the achievement of stock option vesting targets; and • Increased other personnel costs associated with investment management operations.

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 • 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.

Investment Managers Revenues increased $32.6 million, or 17 percent, in 2013 compared to the prior year. Revenues during 2013 were primarily affected by: • Net positive cash flows from existing clients due to new funding along with higher valuations from market appreciation; • Increased accounts from our separately managed account program from new and existing clients; and • Positive cash flows from new clients; partially offset by client losses.

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.

Operating margins were 34 percent in 2013 and 2012. Operating income increased $11.1 million, or 17 percent, in 2013 compared to the prior year. Operating income during 2013 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; • Increased stock-based compensation costs of $4.2 million primarily due to the change in management's estimate of the timing of the achievement of stock option vesting targets; and • Increased investment spending for outsourced technology service providers.

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.

Other Corporate overhead expenses Corporate overhead expenses primarily consist of general and administrative expenses and other costs not directly attributable to a reportable business segment. Corporate overhead expenses were $53.7 million, $45.8 million and $43.4 million in 2013, 2012 and 2011, respectively. The increase in corporate overhead expenses in 2013 was primarily due to increased stock-based compensation of $3.8 million primarily due to the change in management's estimate of the timing of the achievement of stock option vesting targets, other personnel-related costs and higher costs related to regulatory and compliance matters.

Page 26 of 76 -------------------------------------------------------------------------------- Other Income and Expense Items Other income and expense items on the accompanying Consolidated Statements of Operations consist of: Year Ended December 31, 2013 2012 2011 Net gain from investments $ 659 $ 14,067 $ 3,360 Interest and dividend income 3,248 5,696 5,829 Interest expense (535 ) (504 ) (585 ) Equity in earnings of unconsolidated affiliates 118,076 98,671 105,818 Gain on sale of subsidiary 22,112 - - Other income 43,429 - -Total other income and expense items, net $ 186,989 $ 117,930 $ 114,422 Net gain from investments Net gain from investments consists of: Year Ended December 31, 2013 2012 2011 Net realized and unrealized gains (losses) from marketable securities $ 659 $ 1,123 $ (25 ) Gains from SIV securities - 13,240 3,390 Other losses - (296 ) (5 ) Net gain from investments $ 659 $ 14,067 $ 3,360 During 2012 and 2011, we recognized net gains of $13.2 million and $3.4 million, respectively, from SIV securities. 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. 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.

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 and April 2013, these contributing partners agreed to provide a partnership interest to the LSV employees thereby reducing our interest in LSV to approximately 39.3 percent from 41.2 percent. The issuance in April 2013 reflected the remaining amount of the designated partnership interest of the contributing partners.

Our proportionate share in the earnings of LSV was $119.0 million and $100.0 million in 2013 and 2012, respectively. The increase in our earnings was primarily due to increased assets under management of LSV from new and existing clients due to improved capital markets and an increase in performance fees. In 2012, our proportionate share in the earnings of LSV decreased to $100.0 million from $105.8 million in 2011. The decrease 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.

Gain on sale of subsidiary On March 28, 2013, the sale of all of our ownership interests in SEI AK was completed. We recorded a gain from the sale of $22.1 million during 2013 which is included in Gain on sale of subsidiary on the accompanying Consolidated Statement of Operations (See Note 15 to the Consolidated Financial Statements for more information).

Other income On April 24, 2013, we entered into a Settlement Agreement with respect to litigation captioned Abu Dhabi Commercial Bank, et. al. v. Morgan Stanley & Co., Incorporated, et. al., related to the purchase of Cheyne Finance LLC, a SIV security. In accordance with the Settlement Agreement, we received a cash settlement payment after fees and expenses of $43.4 million during 2013 which is included in Other income on the accompanying Consolidated Statement of Operations (See Note 16 to the Consolidated Financial Statements for more information).

Income Taxes Our effective tax rate was 33.7 percent in 2013, 36.9 percent in 2012, and 35.2 percent in 2011. Our effective tax rate is affected by recurring items, such as tax rates in various states and foreign jurisdictions and the relative amount of income we earned in those jurisdictions. These amounts have been fairly consistent over the time period.

Page 27 of 76 -------------------------------------------------------------------------------- Our effective tax rate is also affected by discrete items that may occur in any given year, but are not consistent from year to year. Below are the most significant discrete items: 2013 • There was a 2.4 percent reduction in our effective rate that was the result of Pennsylvania Tax Law changes enacted on July 18, 2013 which became effective on January 1, 2014. These changes have reduced the deferred tax liability which had accumulated during prior years. In accordance with the tax accounting rules, the effect of the law change is recorded in the year in which the law was signed. The primary change that affects SEI results from the reduction of net income apportioned to the State of Pennsylvania. The bill adopts "market-based" sourcing for apportionment. This method apportions sales to the state where the benefits are being derived by the customer. The current method apportions sales of services to the state where the cost was incurred to perform those services; and • There was a 0.8 percent reduction in our effective rate from the reinstatement of the research and development tax credit. The tax credit was reinstated retroactively from January 1, 2012 through December 31, 2013 through The American Taxpayer Relief Act of 2012 (the Act), signed into law on January 2, 2013. The accounting rules require the determination of current and deferred taxes be based upon the provisions of the enacted tax law as of the balance sheet date. Since the Act was not signed into law until January 2, 2013, the effect was not reflected in the tax provision for 2012. The 2013 effective tax rate reflects a research and development tax credit for both 2012 and 2013.

2012• There was a 1.5 percent increase in our effective tax rate as a result of the sale of SEI AK because we no longer considered the undistributed earnings of SEI AK to be indefinitely reinvested and, therefore, accrued U.S. deferred taxes on the cumulative undistributed earnings; • There was a 0.5 percent increase in our effective tax rate as a result of the expiration of the research and development tax credit; and • There was a 1.1 percent reduction in our effective tax rate as a result of state tax planning.

2011• There was a 1.6 percent reduction in our effective tax rate as a result of the 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.

Stock-Based Compensation During 2013, 2012 and 2011, we recognized approximately $37.9 million, $15.7 million and $14.1 million, respectively, in stock-based compensation expense.

All of our stock options have performance-based vesting provisions that tie vesting of the options to our financial performance. The amount of stock-based compensation expense recognized is based upon an estimate of when the earnings per share targets may be achieved. If our estimate proves to be inaccurate, the amount of stock-based compensation expense could be accelerated, spread out over a longer period, or reversed. This may cause volatility in the recognition of stock-based compensation expense and materially affect our earnings.

During 2013, we revised the estimate made as of December 31, 2012 of when certain vesting targets are expected to be achieved. This change in management's estimate resulted in an increase of $19.6 million in stock-based compensation expense. The change in our estimate resulted from the positive earnings impacts from the unexpected cash payment received for the litigation settlement and the gain recognized from the sale of SEI AK during 2013. These non-recurring events, which were not part of our normal business operations, had a significant positive impact on our earnings and were not initially incorporated into our estimate made at December 31, 2012 for the achievement of our option vesting targets. 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 2014 $ 9,717 2015 9,717 2016 9,529 2017 5,201 2018 1,597 2019 1,505 $ 37,266 Page 28 of 76-------------------------------------------------------------------------------- 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 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 GNMA and other U.S.

government agency securities that are single issuer pools that are valued based on current market data of similar assets. We did not have any financial liabilities at December 31, 2013 or 2012 (See Note 5 to the Consolidated Financial Statements for more information).

Regulatory Matters Like many firms operating within the financial services industry, we are experiencing a challenging 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 Office of the Comptroller of the Currency, the Securities and Exchange Commission, the Financial Industry Regulatory Authority, the Financial Conduct 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, 2013 2012 2011 Net cash provided by operating activities $ 351,224 $ 257,490 $ 256,962 Net cash (used in) provided by investing activities (62,413 ) 16,627 (31,950 ) Net cash used in financing activities (162,785 ) (242,856 ) (300,318 ) Net increase (decrease) in cash and cash equivalents 126,026 31,261 (75,306 ) Cash and cash equivalents, beginning of year 452,247 420,986 496,292 Cash and cash equivalents, end of year $ 578,273 $ 452,247 $ 420,986 Cash requirements and liquidity needs are primarily funded through our cash flow from operations and our capacity for additional borrowing. At December 31, 2013, our unused sources of liquidity consisted of cash and cash equivalents and the full amount available under our credit facility.

Our credit facility provides for borrowings of up to $300.0 million and is scheduled to expire in February 2017 (See Note 7 to the Consolidated Financial Statements). The availability of the 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 our 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, 2014, the amount of cash and cash equivalents considered free and immediately accessible for other general corporate purposes was $316.3 million.

Page 29 of 76 -------------------------------------------------------------------------------- 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 $93.7 million in 2013 compared to 2012 due to the increase in income from operations, the cash payment of $43.4 million received pertaining to a litigation settlement and an additional quarterly partnership distribution payment received from LSV due to a change in the timing of payments (See Note 16 to the Consolidated Financial Statements for more information regarding the litigation settlement).

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.

Cash flows from investing activities decreased $79.0 million in 2013 compared to 2012 and increased $48.6 million in 2012 compared to 2011. Net cash used in investing activities includes: •Purchases, sales and maturities of marketable securities. Our purchases, sales and maturities of marketable securities during 2013, 2012 and 2011 were as follows: Year Purchases Sales and Maturities 2013 $ 57,560 $ 47,574 2012 33,662 108,182 2011 73,960 99,829 Marketable securities purchased generally consisted of additional GNMA securities to satisfy applicable regulatory requirements of SPTC, 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. Proceeds received from sales and maturities primarily included principal prepayments from GNMA securities, maturities of short-term securities owned by SIDCO and, in 2012 and 2011, the sales of our remaining SIV securities.

• The capitalization of costs incurred in developing computer software. We capitalized $39.5 million, $31.0 million and $41.0 million of software development costs in 2013, 2012 and 2011, respectively. Amounts capitalized in each year include costs for significant enhancements and upgrades for the expanded functionality of the SEI Wealth Platform. Included in the amount for 2013 is a one-time contractual payment of $8.8 million to exercise a conversion option in lieu of periodic fee payments pertaining to a software license for the Platform.

• Capital expenditures. Our capital expenditures in 2013, 2012 and 2011 primarily include purchased software and equipment for our data center operations. Our expenditures in 2012 include a purchase of $10.0 million for specific front office client management technology. During the third quarter 2013, we began construction of an additional building at our corporate headquarters. The total cost of the expansion is estimated to be at least $10.6 million and is expected to be completed in the second quarter of 2014.

• The sale of our subsidiary. The sale of SEI AK was completed during the first quarter of 2013. Prior to the transaction, cash and cash equivalents held in the accounts of SEI AK were not considered free and immediately available. As a result of the sale, the net cash proceeds received significantly increased our amount of cash considered free and immediately accessible for other general corporate purposes. The net effect of the cash received from the sale of SEI AK and the transfer of cash balances to the owners is reflected in Sale of subsidiary, net of cash transferred.

Additional information pertaining to the sale is presented in Note 15 to the Consolidated Financial Statements.

Page 30 of 76-------------------------------------------------------------------------------- Cash flows from financing activities increased $80.1 million in 2013 compared to 2012 and increased $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 2013, 2012 and 2011: Total Number of Average Price Year Shares Repurchased Paid per Share Total Cost 2013 6,789,000 $ 30.92 $ 209,942 2012 7,528,000 20.62 155,264 2011 11,109,000 19.01 211,165 • Proceeds from the issuance of our common stock. We received $66.4 million, $49.4 million and $24.2 million in proceeds from the issuance of our common stock during 2013, 2012 and 2011, respectively. The increase in proceeds in 2013 and 2012 is primarily attributable to higher levels of stock option exercise activity.

• Dividend payments. Our cash dividends paid during 2013, 2012 and 2011 were as follows: Cash Dividends Year Cash Dividends Paid Paid per Share 2013 $ 34,400 $ 0.42 2012 135,335 0.78 2011 22,041 0.12 The decrease in dividends paid in 2013 was due to a special cash dividend of $0.32 per share paid 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 2013 which occurred in January of 2014.

Our Board of Directors declared a semi-annual cash dividend of $0.22 per share on December 10, 2013. The dividend was paid on January 10, 2014 for a total of $37.3 million.

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; expansion of our corporate campus 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.

Contractual Obligations and Contingent Obligations As of December 31, 2013, 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: 2018 and Total 2014 2015 2016 to 2017 thereafter Line of credit (a) $ 1,406 $ 456 $ 456 $ 494 $ - Operating leases and maintenance agreements (b) 25,139 7,625 3,918 5,899 7,697 Other commitments (c) 4,175 4,175 - - - Total $ 30,720 $ 12,256 $ 4,374 $ 6,393 $ 7,697 (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.

Page 31 of 76-------------------------------------------------------------------------------- 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.

We did not have any financial liabilities at December 31, 2013 or 2012. The valuation of our Level 2 financial assets are based upon securities pricing policies and procedures utilized by third-party pricing vendors (See Note 5 to the Consolidated Financial Statements).

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, Page 32 of 76-------------------------------------------------------------------------------- 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 2013, 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 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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