News Column

MANHATTAN ASSOCIATES INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations

February 6, 2014

All statements, trend analyses, and other information contained in the following discussion relative to markets for our products and trends in revenue, gross margins, and anticipated expense levels, as well as other statements including words such as "anticipate," "believe," "plan," "estimate," "expect," and "intend" and other similar expressions constitute forward-looking statements. These forward-looking statements are subject to business and economic risks and uncertainties, including those discussed under the caption "Risk Factors" in Item 1A of this Form 10-K, and our actual results of operations may differ materially from those contained in the forward-looking statements.



Business Overview

We are a leading developer and implementer of supply chain commerce software solutions that help organizations optimize their supply chain operations from planning through execution. Our platform-based supply chain software solution portfolios - Manhattan SCOPE® and Manhattan SCALETM - are designed to deliver both business agility and total cost of ownership advantages to customers. Manhattan SCOPE (Supply Chain Optimization, Planning through Execution) leverages our Supply Chain Process Platform (SCPP) to unify the full breadth of the supply chain, while Manhattan SCALE (Supply Chain Architected for Logistics Execution) leverages Microsoft's .NET platform to unify logistics functions. Early in the Company's history, our offerings were heavily focused on warehouse management solutions. As the Company grew in size and scope, our offerings expanded across the entire supply chain, while still maintaining a significant presence in, and a relatively strong concentration of revenues from warehouse management solutions, which is a component of our distribution management solution suite. Over time, as our non-warehouse management solutions have proliferated and increased in capability, the Company's revenue concentration in its warehouse management solutions has correspondingly decreased. Our business model is singularly focused on the development and implementation of complex supply chain commerce software solutions that are designed to optimize supply chain effectiveness and efficiency for our customers. We have three principal sources of revenue: • licenses of our supply chain software; 25



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• professional services, including solutions planning and implementation,

related consulting, customer training, and customer support services and

software enhancements (collectively, "services"); and • hardware sales and other revenue.



In 2013, we generated $414.5 million in total revenue, with a revenue mix of: license revenue 15%; services revenue 76%; and hardware and other revenue 9%.

We manage our business based on three geographic regions: Americas, EMEA, and APAC. Geographic revenue is based on the location of the sale. Our international revenue was approximately $110.8 million, $104.4 million, and $90.7 million for the years ended December 31, 2013, 2012, and 2011, respectively, which represents approximately 27%, 28%, and 28% of our total revenue for the years ended December 31, 2013, 2012, and 2011, respectively. International revenue includes all revenue derived from sales to customers outside the United States. At December 31, 2013, we employed approximately 2,530 employees worldwide, of which 1,160 employees are based in the Americas, 170 employees in EMEA, and 1,200 employees in APAC (including India). We have offices in Australia, China, France, India, Japan, the Netherlands, Singapore, and the United Kingdom, as well as representatives in Mexico and reseller partnerships in Latin America, Eastern Europe, the Middle East, South Africa, and Asia.



Global Economic Trends and Industry Factors

Global macro economic trends, technology spending, and supply chain management market growth are important barometers for our business. In 2013, approximately 73% of our total revenue was generated in the United States, 12% in EMEA, and the balance in APAC, Canada, and Latin America. In addition, Gartner Inc., an information technology research and advisory company, estimates that nearly 80% of every supply chain software solutions dollar invested is spent in the United States (50%) and Western Europe (28%); consequently, the health of the U.S. and the Western European economies has a meaningful impact on our financial results. We sell technology-based solutions with total pricing, including software and services, in many cases exceeding $1.0 million. Our software often is a part of our customers' and prospects' much larger capital commitment associated with facilities expansion and business improvement. We believe that, given the lingering uncertainty in the global macro environment, the current sales cycles for large license sales of $1.0 million or greater in our target markets have been extended. The current business climate within the United States and geographic regions in which we operate continues to affect customers' and prospects' decisions regarding timing of strategic capital expenditures. Delays with respect to such decisions can have a material adverse impact on our business, and may further intensify competition in our already highly competitive markets. In January 2014, the International Monetary Fund (IMF) provided a World Economic Outlook (WEO) update projecting slightly higher global growth for 2014. The WEO update noted that "Global activity and world trade picked up in the second half of 2013. Recent data even suggest that global growth during this period was somewhat stronger than anticipated in the October 2013 WEO. Final demand in advanced economies expanded broadly as expected-much of the upward surprise in growth is due to higher inventory demand. In emerging market economies, an export rebound was the main driver behind better activity, while domestic demand generally remained subdued, except in China. The WEO update projected that growth in the United States is expected to be 2.8 percent in 2014, up from 1.9 percent in 2013." During 2013 and 2012, the overall trend has been steady for our large license sales, with recognized $1.0 million or larger software license sales totaling fourteen, twelve, and thirteen for 2013, 2012, and 2011,respectively. However, the large deal flow has been inconsistent from quarter to quarter, reflecting what we believe to be ongoing macroeconomic uncertainty in the United States and Western Europe. While we are encouraged by our 2013 and 2012 results, we, along with many of our customers, still remain cautious regarding the pace of global economic recovery. With global GDP growth continuing to be well below pre-2008 levels, we believe global economic volatility likely will continue to shape customers' and prospects' enterprise software buying decisions, making it more difficult to forecast sales cycles for our products and the timing of large enterprise software license sales.



Revenue

License revenue: License revenue, a leading indicator of our business, is primarily derived from software license fees that customers pay for supply chain solutions. In 2013, license revenue totaled $62.4 million, or 15% of total revenue, with gross margins of 86%. For the year ended December 31, 2013, Americas, EMEA, and APAC recognized $49.5 million, $7.9 million, and $5.0 million in license revenue, respectively. Our typical license revenue percentage mix of new to existing customers historically has 26



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approximated 50/50. However, for the year ended December 31, 2013, the percentage mix of new to existing customers was approximately 35/65. We believe our current mix of new customer to existing customer license sales will fluctuate with continuing global macroeconomic uncertainty; however, we anticipate that the mix will be at historically normal levels on a more consistent basis in improved global economic conditions.

License revenue growth is influenced by the strength of general economic and business conditions and the competitive position of our software products. Our license revenue generally has long sales cycles. In addition, the timing of the closing of a few large license transactions can have a material impact on our license revenues, operating profit, operating margins and earnings per share. For example, $1.0 million of license revenue in 2013 equates to approximately one cent of diluted earnings per share impact. Our software solutions are singularly focused on the supply chain commerce planning and execution markets, which are intensely competitive and characterized by rapid technological change. We are a market leader in the supply chain management software solutions market as defined by industry analysts such as ARC Advisory Group and Gartner. Our goal is to extend our position as a leading global supply chain solutions provider by growing our license revenues faster than our competitors through investment in innovation. We expect to continue to face increased competition from Enterprise Resource Planning (ERP) and Supply Chain Management application vendors and business application software vendors that may broaden their solution offerings by internally developing, or by acquiring or partnering with independent developers of supply chain planning and execution software. Increased competition could result in price reductions, fewer customer orders, reduced gross margins, and loss of market share. Services revenue: Our services business consists of professional services (consulting and customer training) and customer support services and software enhancements ("CSSE"). In 2013, our services revenue totaled $315.9 million, or 76% of total revenue, with gross margins of 55.0%. The Americas, EMEA, and APAC recognized $254.9 million, $41.0 million, and $20.0 million, respectively, in services revenue for the year ended December 31, 2013. Professional services accounted for approximately 67% of total services revenue and approximately 51% of total revenue in 2013. Our consolidated operating margin profile may be lower than those of various other technology companies due to our large services revenue mix as a percentage of total revenue. While we believe our services margins are very strong, they do lower our overall operating margin profile as services margins are inherently lower than license revenue margins. At December 31, 2013, our professional services organization totaled approximately 1,560 employees, accounting for 62% of our total employees worldwide. Our professional services organization provides our customers with expertise and assistance in planning and implementing our solutions. To ensure a successful product implementation, consultants assist customers with the initial installation of a system, the conversion and transfer of the customer's historical data onto our system, and ongoing training, education, and system upgrades. We believe our professional services enable customers to implement our software rapidly, ensure the customer's success with our solution, strengthen our customer relationships, and add to our industry-specific knowledge base for use in future implementations and product innovations. Although our professional services are optional, the majority of our customers use at least some portion of these services for their planning, implementation, or related needs. Professional services are typically rendered under time and materials-based contracts with services typically billed on an hourly basis. Professional services are sometimes rendered under fixed-fee based contracts with payments due on specific dates or milestones. Typically, our professional services lag license revenue by several quarters, as implementation services and related consulting are performed after the purchase of the software. Services revenue growth is contingent upon license revenue and customer upgrade cycles, which is influenced by the strength of general economic and business conditions and the competitive position of our software products. In addition, our professional services business has competitive exposure to offshore providers and other consulting companies. All of these factors potentially create the risk of pricing pressure, fewer customer orders, reduced gross margins, and loss of market share. For CSSE, we offer a comprehensive 24 hours per day, 365 days per year program that provides our customers with software upgrades, when and if available, which include additional or improved functionality and technological advances incorporating emerging supply chain and industry initiatives. Our CSSE revenues totaled $105.1 million in 2013, representing approximately 33% of services revenue and approximately 25% of total revenue, respectively. The growth of CSSE revenues is influenced by: (1) new license revenue growth; (2) annual renewal of support contracts; (3) increase in customers through acquisitions; and (4) fluctuations in currency rates. Substantially all of our customers renew their annual support contracts. Over the last three years, our annual revenue renewal rate of customers subscribing to comprehensive support and enhancements has been greater than 90%. CSSE revenue is generally paid in advance and recognized ratably over the term of the agreement, typically twelve months. CSSE renewal revenue is not recognized unless payment is received from the customer. 27



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Hardware and other revenue: Our hardware and other revenue totaled $36.2 million in 2013 representing 9% of total revenue with gross margins of 16.6%. In conjunction with the licensing of our software, and as a convenience for our customers, we resell a variety of hardware products developed and manufactured by third parties. These products include computer hardware, radio frequency terminal networks, RFID chip readers, bar code printers and scanners, and other peripherals. We resell all third-party hardware products and related maintenance pursuant to agreements with manufacturers or through distributor-authorized reseller agreements pursuant to which we are entitled to purchase hardware products and services at discount prices. We generally purchase hardware from our vendors only after receiving an order from a customer. As a result, we generally do not maintain hardware inventory. Other revenue represents amounts associated with reimbursements from customers for out-of-pocket expenses. The total amount of expense reimbursement recorded to hardware and other revenue was $15.3 million, $12.6 million, and $10.4 million for 2013, 2012, and 2011, respectively.



Product Development

We continue to invest significantly in research and development (R&D) to provide leading solutions that help global manufacturers, wholesalers, distributors, retailers, and logistics providers successfully manage accelerating and fluctuating demands as well as the increasing complexity and volatility of their local and global supply chains. Our research and development expenses for the years ended December 31, 2013, 2012, and 2011 were $44.5 million, $44.7 million, and $42.4 million, respectively. At December 31, 2013, our R&D organization totaled approximately 650 employees, located in the U.S. and India. We expect to continue to focus our R&D resources on the development and enhancement of supply chain software solutions. We offer what we believe to be the broadest solution portfolio in the supply chain solutions marketplace, to address all aspects of planning and forecasting, inventory optimization, order lifecycle management, transportation lifecycle management, and distribution management. We also plan to continue to enhance our existing solutions and to introduce new solutions to address evolving industry standards and market needs. We identify opportunities to further enhance our solutions and to develop and provide new solutions through our customer support organization, as well as through ongoing customer consulting engagements and implementations, interactions with our user groups, association with leading industry analysts and market research firms, and participation on industry standards and research committees. Our solutions address the needs of customers in various vertical markets, including retail, consumer goods, food and grocery logistics service providers, industrial and wholesale, high technology and electronics, life sciences, and government.



Cash Flow and Financial Condition

For 2013, we generated cash flow from operating activities of $89.4 million and have generated a cumulative total of $220.5 million for the three years ended December 31, 2013. Our cash and investments at December 31, 2013 totaled $133.0 million, with no debt on our balance sheet. We currently have no credit facilities. During the past three years, our primary uses of cash have been funding investment in R&D and operations to drive earnings growth and repurchases of common stock. During 2013, we repurchased approximately $59.2 million of Manhattan Associates' outstanding common stock under the share repurchase program approved by our Board of Directors throughout the year. In January 2014, our Board of Directors approved raising our remaining share repurchase authority to $50 million. In 2014, we anticipate that our priorities for use of cash will be in developing sales and services resources and continued investment in product development to drive and support profitable growth and extend our market leadership. We will continue to evaluate acquisition opportunities that are complementary to our product footprint and technology direction. We will also continue to weigh our share repurchase options against cash for acquisitions and investing in the business. We do not anticipate any borrowing requirements in 2014 for general corporate purposes. 28



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Accounting Charges

Recovery of previously impaired investment. In the quarter ended September 30, 2008, we recorded an impairment charge of $3.5 million on an investment in an auction rate security. We reduced the carrying value to zero due to credit downgrades of the underlying issuer and the bond insurer as well as increasing publicly reported exposure to bankruptcy risk by the issuer. In the quarter ended September 30, 2011, we were able to sell the auction rate security recovering 72%, or $2.5 million, of our original investment.



Full Year 2013 Financial Summary

• On December 19, 2013, the Board of Directors approved a four-for-one stock

split of the Company's common stock, effected in the form of a stock dividend. All references made to share or per share amounts have been



restated to reflect the effect of this four-for-one stock split for all

periods presented. • Diluted earnings per share for the twelve months ended December 31, 2013

was $0.86, compared to $0.64 for the twelve months ended December 31, 2012;



• Consolidated revenue for the twelve months ended December 31, 2013 was

$414.5 million, compared to $376.2 million for the twelve months ended

December 31, 2012. License revenue was $62.4 million for the twelve months

ended December 31, 2013, compared to $61.5 million for the twelve months

ended December 31, 2012; • Operating income was $101.3 million for the twelve months ended

December 31, 2013, compared to $80.1 million for the twelve months ended December 31, 2012;



• Operating margins for 2013 were 24.4% compared to operating margins of

21.3% in 2012; • Cash flow from operations totaled $89.4 million for the full year 2013

compared to $75.3 million in 2012; • Cash and investments on hand at December 31, 2013 was $133.0 million compared to $103.0 million at December 31, 2012;



• During the twelve months ended December 31, 2013, the Company repurchased

approximately 2.8 million shares of Manhattan Associates common stock

under the share repurchase program authorized by the Board of Directors,

for a total investment of $59.2 million; and • In January 2014, the Board of Directors approved raising the Company's

remaining share repurchase authority to $50 million of Manhattan Associates' outstanding common stock. 29



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Results of Operations

The following table summarizes selected Statement of Income data for the years ended December 31, 2013, 2012, and 2011.

Year Ended December 31, % Change vs. Prior Year 2013 2012 2011 2013 2012 (in thousands) Revenue: Software license $ 62,416$ 61,494$ 54,241 1 % 13 % Services 315,901 283,872 244,058 11 % 16 % Hardware and other 36,201 30,882 30,954 17 % 0 % Total revenue 414,518 376,248 329,253 10 % 14 % Costs and expenses: Cost of license 8,724 7,838 6,806 11 % 15 % Cost of services 142,236 128,686 107,510 11 % 20 % Cost of hardware and other 30,191 25,213 24,785 20 % 2 % Research and development 44,549 44,704 42,372 0 % 6 % Sales and marketing 44,559 45,622 43,944 -2 % 4 % General and administrative 37,147 38,474 37,708 -3 % 2 % Depreciation and amortization 5,825 5,638 7,284 3 % -23 % Recovery of previously impaired investment (1) - - (2,519 ) N/A N/A Total costs and expenses 313,231 296,175 267,890 6 % 11 % Income from operations $ 101,287$ 80,073$ 61,363 26 % 30 % Operating margin 24.4 % 21.3 % 18.6 %



(1) Amount represents recovery of an auction rate security investment which had

been impaired in a prior period. 30



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We manage our business based on three geographic regions: the Americas, EMEA, and APAC. Geographic revenue information is based on the location of sale. The revenues represented below are from external customers only. The geographical-based expenses include costs of personnel, direct sales, and marketing expenses, and general and administrative costs to support the business. There are certain corporate expenses included in the Americas region that are not charged to the other segments including research and development, certain marketing and general and administrative costs that support the global organization, and the amortization of acquired developed technology. Included in the Americas costs are all research and development costs, including the costs associated with the Company's India operations. During 2013, 2012, and 2011, we derived the majority of our revenues from sales to customers within our Americas region. The following table summarizes revenue and operating profit by region: Year Ended December 31, % Change vs. Prior Year 2013 2012 2011 2013 2012 (in thousands) Revenue: Software license Americas $ 49,574$ 50,036$ 45,506 -1 % 10 % EMEA 7,858 9,569 6,362 -18 % 50 % APAC 4,984 1,889 2,373 164 % -20 % Total license $ 62,416$ 61,494$ 54,241 1 % 13 % Services Americas $ 254,934$ 228,673$ 198,041 11 % 15 % EMEA 41,020 36,167 30,824 13 % 17 % APAC 19,947 19,032 15,193 5 % 25 % Total services $ 315,901$ 283,872$ 244,058 11 % 16 % Hardware and Other Americas $ 33,836$ 28,883$ 29,312 17 % -1 % EMEA 1,536 1,402 1,109 10 % 26 % APAC 829 597 533 39 % 12 % Total hardware and other $ 36,201$ 30,882$ 30,954 17 % 0 % Total Revenue Americas $ 338,344$ 307,592$ 272,859 10 % 13 % EMEA 50,414 47,138 38,295 7 % 23 % APAC 25,760 21,518 18,099 20 % 19 % Total revenue $ 414,518$ 376,248$ 329,253 10 % 14 % Operating income: Americas $ 83,451$ 65,517$ 53,550 27 % 22 % EMEA 10,288 9,725 5,239 6 % 86 % APAC 7,548 4,831 2,574 56 % 88 % Total operating income $ 101,287$ 80,073$ 61,363 26 % 30 %



The results of our operations for the years ended December 31, 2013, 2012, and 2011 are discussed below.

Revenue



Our revenue consists of fees generated from the licensing and hosting of software; fees from professional services, customer support services and software enhancements; hardware sales of complementary radio frequency and computer equipment; and other revenue representing amounts associated with reimbursements from customers for out-of-pocket expenses.

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Year Ended December, 31 % Change vs. Prior Year % of Total Revenue 2013 2012 2011 2013 2012 2013 2012 2011 (in thousands) Software license $ 62,416$ 61,494$ 54,241 1 % 13 % 15 % 16 % 17 % Services 315,901 283,872 244,058 11 % 16 % 76 % 76 % 74 % Hardware and other 36,201 30,882 30,954 17 % 0 % 9 % 8 % 9 % Total revenue $ 414,518$ 376,248$ 329,253 10 % 14 % 100 % 100 % 100 % License revenue



Year 2013 compared with year 2012

License revenue increased $0.9 million, or 1%, to $62.4 million in 2013 compared to 2012. We completed fourteen and twelve large deals greater than $1.0 million in 2013 and 2012, respectively. Our APAC license revenue increased $3.1 million, while Americas and EMEA license revenue decreased $0.5 million and $1.7 million, respectively, over 2012. The license sales percentage mix across our product suite in 2013 was approximately 63% warehouse management solutions and 37% non-warehouse management solutions. Our warehouse management solutions decreased $0.7 million, or 2%, in 2013 compared to 2012 and non-warehouse management solutions increased $1.6 million, or 7%, in 2013 over 2012.



Year 2012 compared with year 2011

License revenue increased $7.3 million, or 13%, to $61.5 million in 2012 compared to 2011. We completed twelve and thirteen large deals greater than $1.0 million in 2012 and 2011, respectively. Our Americas and EMEA license revenue increased $4.5 million and $3.2 million, respectively, while APAC license revenue decreased $0.5 million over 2011.



The license sales percentage mix across our product suite in 2012 was approximately 65% warehouse management solutions and 35% non-warehouse management solutions. Our warehouse management solutions increased $6.5 million, or 19%, in 2012 compared to 2011 and non-warehouse management solutions increased $0.7 million, or 4%, in 2012 over 2011.

Services revenue

Year 2013 compared with year 2012

Services revenue increased $32.0 million, or 11%, in 2013 compared to 2012 due to a $25.6 million, or 14%, increase in professional services revenue and a $6.4 million, or 7%, increase in CSSE revenue. The Americas, EMEA, and APAC segments increased $26.3 million, $4.8 million, and $0.9 million, respectively, compared to 2012. The increase in services revenue is primarily due to customer-specific initiatives in conjunction with customer upgrade activity and license deals signed.



Year 2012 compared with year 2011

Services revenue increased $39.8 million, or 16%, in 2012 compared to 2011 due to a $28.4 million, or 18%, increase in professional services revenue and an $11.4 million, or 13%, increase in CSSE revenue. The Americas, EMEA, and APAC segments increased $30.6 million, $5.3 million, and $3.8 million, respectively, compared to 2011. The increase in services revenue is primarily due to customer-specific initiatives in conjunction with customer upgrade activity and license deals signed. Hardware and other Sales of hardware increased $2.6 million to $20.9 million in 2013 compared to $18.3 million in 2012. Sales of hardware decreased to $18.3 million in 2012 from $20.5 million in 2011. The majority of hardware sales are derived from our Americas segment. Sales of hardware are largely dependent upon customer-specific desires, which fluctuate. Other revenue represents 32



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reimbursements for professional service travel expenses that are required to be classified as revenue and are included in hardware and other revenue. Reimbursements by customers for out-of-pocket expenses were approximately $15.3 million, $12.6 million, and $10.4 million for 2013, 2012, and 2011, respectively. Cost of Revenue Year Ended December 31, % Change vs. Prior Year 2013 2012 2011 2013 2012 (in thousands) Cost of license $ 8,724$ 7,838$ 6,806 11 % 15 % Cost of services 142,236 128,686 107,510 11 % 20 % Cost of hardware and other 30,191 25,213 24,785 20 % 2 % Total cost of revenue $ 181,151$ 161,737$ 139,101 12 % 16 % Cost of License Cost of license consists of the costs associated with software reproduction; hosting services; media, packaging and delivery, documentation, and other related costs; and royalties on third-party software sold with or as part of our products. Cost of license increases in 2013 and 2012 are primarily due to increase in sales of third-party software over the prior year.



Cost of Services

Year 2013 compared with year 2012

Cost of services consists primarily of salaries and other personnel-related expenses of employees dedicated to professional and technical services and customer support services. Cost of services increased $13.6 million, or 11%, in 2013 compared to 2012 principally due to a $11.9 million increase in compensation and other personnel-related expenses resulting from increased headcount in our services organization and an increase of $0.8 million in third-party software maintenance costs and internal computer system costs.

Year 2012 compared with year 2011

Cost of services increased $21.2 million, or 20%, in 2012 compared to 2011 principally due to a $14.3 million increase in employee-related costs such as salary, benefits, and payroll taxes resulting from an increase in the number of professional services personnel in 2012 to support demand and a $3.1 million increase in performance-based compensation expense.



Cost of Hardware and other

In 2013, cost of hardware increased $2.3 million to $15.1 million from $12.8 million in 2012 on increased sales of hardware. In 2012, cost of hardware decreased $1.6 million to $12.8 million from $14.4 million in 2011. Cost of hardware and other includes professional services billed travel expenses reimbursed by customers of approximately $15.1 million, $12.4 million, and $10.4 million for 2013, 2012, and 2011, respectively. Changes in amounts of out-of-pocket expenses correlate to changes in amounts of services revenue. 33



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Operating Expenses Year Ended December 31, % Change vs. Prior Year 2013 2012 2011 2013 2012 (in thousands) Research and development $ 44,549$ 44,704$ 42,372 0 % 6 % Sales and marketing 44,559 45,622 43,944 -2 % 4 % General and administrative 37,147 38,474 37,708 -3 % 2 % Depreciation and amortization 5,825 5,638 7,284 3 % -23 % Recovery of previously impaired investment - - (2,519 ) N/A N/A Operating expenses $ 132,080$ 134,438$ 128,789 -2 % 4 % Research and Development Our principal research and development (R&D) activities during 2013, 2012, and 2011 focused on the expansion and integration of new products and releases, while expanding the product footprint of our supply chain optimization solutions called Supply Chain Optimization from Planning through Execution. The Manhattan SCOPE Platform provides not only a sophisticated service oriented, architecture based application framework, but a platform that facilitates the integration with Enterprise Resource Planning (ERP) and other supply chain solutions. For the years ended December 31, 2013, 2012, and 2011, we did not capitalize any R&D costs because the costs incurred following the attainment of technological feasibility for the related software product through the date of general release were insignificant.



Year 2013 compared with year 2012

R&D expenses primarily consist of salaries and other personnel-related costs for personnel involved in our R&D activities. R&D expenses were essentially flat over prior year due to slightly lower headcount and favorable currency impact driven by a weakening of the Indian rupee against the US dollar.



Year 2012 compared with year 2011

R&D expenses increased $2.3 million, or 6%, to $44.7 million in 2012 compared to $42.4 million in 2011 primarily due to a $1.4 million increase in salary-related costs resulting from an increase in the number of R&D personnel to support our product development and a $1.1 million increase in performance-based compensation expense.



Sales and Marketing

Year 2013 compared with year 2012

Sales and marketing expenses include salaries, commissions, travel, and other personnel-related costs and the costs of our marketing and alliance programs and related activities. Sales and marketing expenses decreased by $1.1 million, or 2%, in 2013 compared to 2012. The decrease was mainly attributable to a $1.2 million decrease in performance-based compensation and a decrease in stock compensation expense of $1.2 million partially offset by an increase in sales and marketing operating expenses of $1.6 million.



Year 2012 compared with year 2011

Sales and marketing expenses increased by $1.7 million, or 4%, in 2012 compared to 2011. The increase was mainly attributable to a $3.1 million increase in performance-based compensation partially offset by a decrease in sales and marketing operating expenses of $1.1 million.

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General and Administrative

Year 2013 compared with year 2012

General and administrative expenses consist primarily of salaries and other personnel-related costs of executive, financial, human resources, information technology, and administrative personnel, as well as facilities, legal, insurance, accounting, and other administrative expenses. General and administrative expenses decreased $1.3 million, or 3%, in 2013 primarily attributable to a $1.6 million reversal of a previously expensed transaction tax resulting from the expiration of the tax audit statutes.



Year 2012 compared with year 2011

General and administrative expenses increased $0.8 million, or 2%, in 2012 primarily attributable to an increase in compensation, employee-related expenses, and temporary contracted personnel of $1.8 million and an increase in performance-based compensation expense of $0.4 million partially offset by a $1.1 million decrease in equity-based compensation and a $0.7 million decrease in professional fees.



Depreciation and Amortization

Depreciation expense amounted to $5.8 million, $5.6 million, and $6.1 million during 2013, 2012, and 2011, respectively, and has decreased due to lower capital expenditures over the past several years. Amortization of intangibles was nil in 2013 and 2012, and $2.3 million in 2011. We have recorded goodwill and other acquisition-related intangible assets as part of the purchase accounting associated with various acquisitions prior to 2006. The decreases in amortization expense in 2013 and 2012 were associated with certain finite-lived intangible assets related to prior acquisitions, which are now fully amortized.



Recovery of previously impaired investment

In the quarter ended September 30, 2011, we were able to sell a previously impaired auction rate security, recovering 72%, or $2.5 million, of our original investment.

Operating Income Operating income for the year ended December 31, 2013 increased $21.2 million to $101.3 million, compared to $80.1 million for the year ended December 31, 2012. Operating margins were 24.4% for 2013 versus 21.3% for 2012. Operating income and margin for the year ended December 31, 2013 included a $1.6 million reversal of a previously expensed transaction tax resulting from the expiration of the tax audit statutes. Furthermore, operating income and margins increased due to strong revenue growth and expense management during the year in addition to favorable foreign currency translation effects of $1.9 million for the year ended December 31, 2013, primarily due to the weakening of the Indian Rupee versus the U.S. dollar during the year ended December 31, 2013 compared to the same period in the prior year. Operating income in the Americas, EMEA, and APAC segments increased by $17.9 million, $0.6 million, and $2.7 million, respectively in 2013. Operating income for the year ended December 31, 2012 increased $18.7 million to $80.1 million, compared to $61.4 million, which includes a $2.5 million recovery of an auction rate security investment which had been impaired in a prior period, for the year ended December 31, 2011. Operating margins were 21.3% for 2012 versus 18.6% for 2011. Operating income and margins increased due to increased services revenue. Operating income in the Americas, EMEA, and APAC segments increased by $12.0 million, $4.5 million, and $2.2 million, respectively in 2012.



Other Income (Loss) and Income Taxes

Year Ended December 31, % Change vs. Prior Year

2013 2012 2011 2013 2012 Other income, net $ 1,822$ 965$ 1,864 89 % -48 % Income tax provision 35,813 29,185 18,320 23 % 59 % 35



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Other Income, net

Other income, net primarily includes interest income, foreign currency gains and losses, and other non-operating expenses. Interest income was $1.2 million for the year ended December 31, 2013 and $1.1 million for the years ended December 31, 2012 and 2011. The weighted-average interest rate earned on cash and investments was approximately 1% for the years ended December 31, 2013, 2012 and 2011. We recorded a net foreign currency gain of $0.7 million in 2013, a net foreign currency loss of $0.1 million in 2012, and a net foreign currency gain of $0.8 million in 2011. The foreign currency gain and losses mainly resulted from gains or losses on intercompany transactions denominated in foreign currencies with subsidiaries due to the fluctuation of the U.S. dollar relative to other foreign currencies, primarily the Indian Rupee.



Income Tax Provision

Our effective income tax rates were 34.7%, 36.0%, and 29.0% in 2013, 2012, and 2011, respectively. Our effective income tax rate takes into account the source of taxable income, domestically by state and internationally by country, and available income tax credits. The effective tax rate in 2013 decreased from 2012 mainly due to the reinstatement of the federal research and development tax credit in January 2013 for the 2012 and 2013 tax years as well as reductions in valuation allowances for state tax credit carryforwards, partially offset by increases in foreign taxes and reserves for uncertain tax positions. The effective rate for the year ended December 31, 2011 was impacted by the $2.5 million recovery of a previously impaired auction rate security investment discussed above. We did not record a tax benefit in 2008 on the original impairment charge as there were no future capital gains to offset the loss, and we therefore did not have tax expense related to the recovery of the charge. Also, the effective tax rate in 2011 included a $2.0 million tax benefit resulting from the reduction of a valuation allowance associated with tax credit carryforwards and deferred tax assets in India. The benefit was attributable to the elimination of the tax holiday for Indian companies under the Software Technology Park of India (STPI) tax plan, based on the February 2011 budget approved by the India Finance Ministry, which will allow us to utilize tax assets previously reserved. In addition, the effective tax rate for the year ended December 31, 2011 included a tax benefit from the disqualifying disposition of incentive stock options that were previously expensed and the reduction of income tax reserves that resulted from the expiration of tax audit statutes and the settlement of an IRS audit.



Liquidity and Capital Resources

During 2013, 2012, and 2011, we funded our business through cash generated from operations. Our cash and investments as of December 31, 2013 included $95.3 million held in the U.S. and $37.7 million held by our foreign subsidiaries. We believe that our cash balances in the U.S. are sufficient to fund our U.S. operations. In the future, if we elect to repatriate the unremitted earnings of our foreign subsidiaries in the form of dividends or otherwise, we would be subject to additional U.S. income taxes which would result in a higher effective tax rate. However, our intent is to indefinitely reinvest these funds outside of the U.S. and we do not have a current cash requirement need to repatriate them to the U.S. Our cash flow from operating activities totaled $89.4 million, $75.3 million, and $55.8 million in 2013, 2012, and 2011, respectively. Typical factors affecting our cash provided by operating activities include our level of revenue and earnings for the period, the timing and amount of employee bonus payments and income tax payments, and the timing of cash collections from our customers which is our primary source of operating cash flow. Cash flow from operating activities for 2013 increased $14.1 million compared to 2012 primarily attributable to higher revenue and net earnings. Cash flow from operating activities for 2012 increased $19.4 million compared to 2011 primarily attributable to higher revenue and net earnings combined with lower tax payments in 2012. Days sales outstanding (DSO) was 61, 60, and 62 days at December 31, 2013, 2012, and 2011, respectively, reflecting solid cash collections. Our investing activities used cash of approximately $7.8 million, $7.0 million, and $4.6 million in 2013, 2012, and 2011, respectively. The use of cash for investing activities for the year ended December 31, 2013 was for capital expenditures of approximately $4.7 million and net purchases of $3.1 million in investments. The use of cash for investing activities for the year ended December 31, 2012 was $7.9 million in capital expenditures partially offset by the net maturities of $0.9 million in investments. The use of cash for investing activities for the year ended December 31, 2011 was $5.1 million in capital expenditures partially offset by the net maturities of $0.5 million in investments. Our financing activities used cash of approximately $51.8 million, $63.5 million, and $77.9 million in 2013, 2012, and 2011, respectively. The principal use of cash for financing activities for the year ended December 31, 2013 was to purchase approximately $64.2 million of our common stock, including $5.0 million for shares withheld for taxes due upon vesting of restricted stock, partially 36



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offset by proceeds generated from options exercised of $5.8 million and a $6.6 million excess tax benefit related to the exercise of stock options and vesting of restricted stock awards. The principal use of cash for financing activities for the year ended December 31, 2012 was to purchase approximately $103.2 million of our common stock, including $3.5 million for shares withheld for taxes due upon vesting of restricted stock, partially offset by proceeds generated from options exercised of $32.1 million and a $7.5 million excess tax benefit related to the exercise of stock options and vesting of restricted stock awards. The principal use of cash for financing activities for the year ended December 31, 2011 was to purchase approximately $133.1 million of our common stock, including $2.4 million for shares withheld for taxes due upon vesting of restricted stock, partially offset by proceeds generated from options exercised of $52.7 million and a $2.5 million excess tax benefit related to the exercise of stock options and vesting of restricted stock awards. In January 2014, our Board of Directors increased our remaining share repurchase authority to a total of $50 million. Periodically, opportunities may arise to grow our business through the acquisition of complementary products, and technologies. Any material acquisition could result in a decrease to our working capital depending on the amount, timing, and nature of the consideration to be paid. We believe that our existing cash and investments will be sufficient to meet our working capital and capital expenditure needs at least for the next twelve months, although there can be no assurance that this will be the case. In 2014, we anticipate that our priorities for use of cash will be similar to prior years, with our first priority being continued investment in product development and profitably growing our business to extend our market leadership. We will continue to evaluate acquisition opportunities that are complementary to our product footprint and technology direction. We will also continue to weigh our share repurchase options against cash for acquisitions and investing in the business. We do not anticipate any borrowing requirements in 2014 for general corporate purposes. New Accounting Pronouncements In February 2013, the Financial Accounting Standard Board (FASB) issued an Accounting Standards Update (ASU) on reporting of amounts reclassified out of accumulated other comprehensive income, which is an amendment to the Presentation of Comprehensive Income Topic of the FASB Accounting Standards Codification. The ASU requires disclosure of amounts reclassified out of accumulated other comprehensive income by component. In addition, companies are required to present either on the face of the financial statements or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income, but only if the amount reclassified is required to be reclassified to net income in its entirety in the same reporting period. For amounts that are not required to be reclassified in their entirety to net income, companies are required to cross-reference to other disclosures that provide additional detail about those amounts. This guidance is effective prospectively for annual and interim periods beginning after December 15, 2012. We adopted the ASU in our first quarter of 2013 reporting, which did not have an impact on our financial statements. In July 2013, the FASB issued an ASU on presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists, an amendment to the Income Taxes Topic of the FASB Accounting Standards Codification. The ASU requires companies to net the liability related to an unrecognized tax benefit against a deferred tax asset for a loss or other carryforward that would apply in settlement of the uncertain tax positions. In addition, under this ASU, unrecognized tax benefits will be netted against all available same-jurisdiction loss or other tax carryforwards that would be utilized, rather than only against carryforwards that are created by the unrecognized tax benefits. This guidance is effective prospectively for annual and interim periods beginning after December 15, 2013 but may be adopted earlier. We adopted this ASU as of December 31, 2013. The adoption of the ASU did not have a material impact on our financial statements.



Off-Balance Sheet Arrangements and Aggregate Contractual Obligations

Our principal commitments as of December 31, 2013 consist of obligations under operating leases. We expect to fulfill all of the following commitments from our working capital. We have no off-balance sheet arrangements within the meaning of SEC rules. Lease Commitments We lease our facilities and some of our equipment under noncancelable operating lease arrangements that expire at various dates through 2018. Rent expense for these leases aggregated $5.9 million, $5.8 million, and $5.7 million during 2013, 2012, and 2011, respectively. 37



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The following table summarizes our contractual commitments as of December 31, 2013 (in thousands): Total 2014 2015



2016 2017 2018 Thereafter Operating Lease Obligations $ 28,405$ 6,248$ 6,098$ 6,009$ 5,900$ 4,150 $ -

Indemnities Our customer contracts generally contain infringement indemnity provisions. Under those provisions, we generally agree, subject to certain exceptions, to indemnify, defend, and hold harmless the customer in connection with third party claims against the customer alleging that the customer's use of our software products in compliance with their license infringe the third party's patent, copyright, or other intellectual property rights. Conditions to our obligations generally include that we are provided the right to control the defense of the claims and, in general, to control settlement negotiations. Those provisions generally provide also that, if the customer is prevented from using our software because of a third party infringement claim, our sole obligation (in addition to the indemnification, defense, and hold harmless obligation referred to above) is to, at our expense, (i) procure for the customer the right to continue to use the software, (ii) to replace or modify the product so that its use by the customer does not infringe, or, if either of the foregoing are not reasonably feasible, to terminate the customer contract and provide a refund of the unamortized portion of the customer's license fee (based on a five year amortization period). Our customer contracts sometimes also require us to indemnify, defend, and hold harmless the customer in connection with death, personal injury, or property damage claims made by third parties with respect to actions of our personnel or contractors. The indemnity obligations contained in our customer contracts generally have no specified expiration date and no specified monetary limitation on liability. We have not previously incurred costs to settle claims or pay awards under these indemnification obligations. We account for these indemnity obligations in accordance with FASB guidance on accounting for contingencies, and record a liability for these obligations when a loss is probable and reasonably estimable. We have not recorded any liabilities for these contracts as of December 31, 2013.



Warranties

In general, in our customer contracts we warrant to our customers that our software products will perform in all material respects in accordance with our standard published specifications in effect at the time of delivery of the licensed products to the customer for six months after first use of the licensed products, but no more than 24 months after execution of the license agreement. Additionally, we warrant to our customers that our services will be performed consistent with generally accepted industry standards or specific service levels through completion of the agreed upon services. If necessary, we would provide for the estimated cost of product and service warranties based on specific warranty claims and claim history. However, we have not incurred significant recurring expense under our product or service warranties. As a result, we believe the estimated fair value of these agreements is nominal. Accordingly, we have no liabilities recorded for these agreements as of December 31, 2013.



Application of Critical Accounting Policies and Estimates

The SEC defines "critical accounting policies" as those that require application of management's most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods. Our consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (GAAP). The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions in certain circumstances that affect amounts reported in the accompanying consolidated financial statements and related footnotes. We believe that estimates, judgments, and assumptions upon which we rely are reasonable based on information available to us at the time that these estimates, judgments, and assumptions are made. To the extent there are material differences between those estimates, judgments, or assumptions and actual results, our financial statements will be affected. The accounting policies that reflect our more significant estimates, judgments, and assumptions are: Revenue Recognition, Allowance for Doubtful Accounts, Valuation of Goodwill, Accounting for Income Taxes, and Stock-based Compensation.



Revenue Recognition

The Company's revenue consists of fees from the licensing and hosting of software (collectively included in "Software license" revenue in the Consolidated Statements of Income), fees from implementation and training services (collectively, "professional services") and customer support services and software enhancements (collectively included in "Services" revenue in the

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Consolidated Statements of Income), and sales of hardware and other revenue, which consists of reimbursements of out-of-pocket expenses incurred in connection with our professional services (collectively included in "Hardware and other" revenue in the Consolidated Statements of Income). All revenue is recognized net of any related sales taxes. The Company recognizes license revenue when the following criteria are met: (1) a signed contract is obtained covering all elements of the arrangement, (2) delivery of the product has occurred, (3) the license fee is fixed or determinable, and (4) collection is probable. Revenue recognition for software with multiple-element arrangements requires recognition of revenue using the "residual method" when (a) there is vendor-specific objective evidence (VSOE) of the fair values of all undelivered elements in a multiple-element arrangement that is not accounted for using long-term contract accounting, (b) VSOE of fair value does not exist for one or more of the delivered elements in the arrangement, and (c) all other applicable revenue-recognition criteria for software revenue recognition, are satisfied. For those contracts that contain significant customization or modifications, license revenue is recognized using contract accounting. The Company allocates revenue to customer support services and software enhancements and any other undelivered elements of the arrangement based on VSOE of fair value of each element and such amounts are deferred until the applicable delivery criteria and other revenue recognition criteria have been met. The balance of the revenue, net of any discounts inherent in the arrangement, is recognized at the outset of the arrangement using the residual method as the product licenses are delivered. If the Company cannot objectively determine the fair value of each undelivered element based on the VSOE of fair value, the Company defers revenue recognition until all elements are delivered, all services have been performed, or until fair value can be objectively determined. The Company must apply judgment in determining all elements of the arrangement and in determining the VSOE of fair value for each element, considering the price charged for each product on a stand-alone basis or applicable renewal rates. For arrangements that include future software functionality deliverables, the Company accounts for these deliverables as a separate element of the arrangement. Because the Company does not sell these deliverables on a standalone basis, the Company is not able to establish VSOE of fair value of these deliverables. As a result, the Company defers all revenue under the arrangement until the future functionality has been delivered to the customer. Payment terms for the Company's software licenses vary. Each contract is evaluated individually to determine whether the fees in the contract are fixed or determinable and whether collectibility is probable. Judgment is required in assessing the probability of collection, which is generally based on evaluation of customer-specific information, historical collection experience, and economic market conditions. If market conditions decline, or if the financial conditions of customers deteriorate, the Company may be unable to determine that collectibility is probable, and the Company could be required to defer the recognition of revenue until the Company receives customer payments. The Company has an established history of collecting under the terms of its software license contracts without providing refunds or concessions to its customers. Therefore, the Company has determined that the presence of payment terms that extend beyond contract execution in a particular contract do not preclude the conclusion that the fees in the contract are fixed or determinable. Although infrequent, when payment terms in a contract extend beyond twelve months, the Company has determined that such fees are not fixed or determinable and recognizes revenue as payments become due provided that all other conditions for revenue recognition have been met. The Company's services revenue consists of fees generated from professional services and customer support and software enhancements related to the Company's software products. Professional services include system planning, design, configuration, testing, and other software implementation support and are not typically essential to the functionality of our software. Fees from professional services performed by the Company are separately priced and are generally billed on an hourly basis, and revenue is recognized as the services are performed. In certain situations, professional services are rendered under agreements in which billings are limited to contractual maximums or based upon a fixed-fee for portions of or all of the engagement. Revenue related to fixed-fee based contracts is recognized on a proportional performance basis based on the hours incurred on discrete projects within an overall services arrangement. The Company has determined that output measures, or services delivered, approximate the input measures associated with fixed-fee services arrangements. Project losses are provided for in their entirety in the period in which they become known. Revenue related to customer support services and software enhancements is generally paid in advance and recognized ratably over the term of the agreement, typically twelve months. Hardware and other revenue is generated from the resale of a variety of hardware products, developed and manufactured by third parties, that are integrated with and complementary to the Company's software solutions. As part of a complete solution, the Company's customers periodically purchase hardware from the Company for use with the software licenses purchased from the Company. These products include computer hardware, radio frequency terminal networks, RFID chip readers, bar code printers and scanners, and other peripherals. Hardware revenue is recognized upon shipment to the customer when title passes. The Company generally purchases hardware from the Company's vendors only after receiving an order from a customer. As a result, the Company generally does not maintain hardware inventory. 39



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In accordance with the other presentation matters within the Revenue Recognition Topic of the FASB's Accounting Standards Codification, the Company recognizes amounts associated with reimbursements from customers for out-of-pocket expenses as revenue. Such amounts have been included in "Hardware and other" revenue in the Consolidated Statements of Income. The total amount of expense reimbursement recorded to revenue was $15.3 million, $12.6 million, and $10.4 million for 2013, 2012, and 2011, respectively.



Allowance for Doubtful Accounts

We continuously monitor collections and payments from our customers and maintain an allowance for doubtful accounts based upon our historical experience and any specific customer collection issues that we have identified. Additions to the allowance for doubtful accounts generally represent a sales allowance on services revenue, which are recorded to operations as a reduction to services revenue. While such losses have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same loss rates that we have in the past.



Valuation of Goodwill

In accordance with the Intangibles - Goodwill and Other Topic of the FASB Accounting Standards Codification, we do not amortize goodwill and other intangible assets with indefinite lives. Our goodwill is subject to an annual impairment test, which requires us to estimate the fair value of our business compared to the carrying value. When evaluating goodwill for impairment, we may first perform a qualitative assessment to determine whether it is more likely than not that the fair value of the reporting unit is greater than its carrying amount based on economic, industry and company-specific factors. If it is determined that the carrying value of the reporting unit exceeds its fair value, an additional step is performed to measure the amount of the impairment loss, if any. The impairment review requires an analysis of future projections and assumptions about our operating performance. Should such review indicate the assets are impaired, we would record an expense for the impaired assets. Annual tests or other future events could cause us to conclude that impairment indicators exist and that our goodwill is impaired. For example, if we had reason to believe that our recorded goodwill had become impaired due to decreases in the fair market value of the underlying business, we would have to record a charge to income for that portion of goodwill that we believed was impaired. Any resulting impairment loss could have a material adverse impact on our financial position and results of operations. At December 31, 2013, our goodwill balance was $62.3 million.



Accounting for Income Taxes

We provide for the effect of income taxes on our financial position and results of operations in accordance with the Income Taxes Topic of the FASB Accounting Standards Codification. Under this accounting pronouncement, income tax expense is recognized for the amount of income taxes payable or refundable for the current year and for the change in net deferred tax assets or liabilities resulting from events that are recorded for financial reporting purposes in a different reporting period than recorded in the tax return. Management must make significant 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 our net deferred tax asset. Our judgments, assumptions, and estimates relative to the current provision for income tax take into account current tax laws, our interpretation of current tax laws, allowable deductions, projected tax credits, and possible outcomes of current and future audits conducted by foreign and domestic tax authorities. We do not recognize a tax benefit unless we conclude that it is more likely than not that the benefit will be sustained on audit by the taxing authority based solely on the technical merits of the associated tax position. If the recognition threshold is met, we recognize a tax benefit measured at the largest amount of the tax benefit that, in our judgment, is greater than 50 percent likely to be realized. Changes in tax law or our interpretation of tax laws and the resolution of current and future tax audits could significantly impact the amounts provided for income taxes in our financial position and results of operations. Our assumptions, judgments, and estimates relative to the value of our net deferred tax asset take into account predictions of the amount and category of future taxable 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, thus materially impacting our financial position and results of operations. 40



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Equity-Based Compensation

In January 2012, in order to simplify equity grant administration, we changed our practice of granting restricted stock in favor of granting restricted stock units, or RSUs, which convert to our common stock upon vesting. There is no material difference between the grant of restricted stock and the grant of RSUs to either us or the recipients receiving the grants; however, in contrast to the granting of restricted stock, no stock will actually be issued under the granting of RSUs until the units vest. We do not currently grant stock options. The restricted stock awards and restricted stock units contain vesting provisions that are 50% service-based and 50% performance-based. The awards have a four year vesting period, with the performance portion tied to their grant year revenue and adjusted earnings per share targets. We recognize compensation cost for service-based awards with graded vesting on a straight-line basis over the entire vesting period, with the amount of compensation cost recognized at any date at least equal to the portion of the grant-date value of the award that is vested at that date. For our performance-based restricted stock awards with graded vesting, we recognize compensation cost on an accelerated basis applying straight-line expensing for each separately vesting portion of each award. Compensation cost recognized in any period is impacted by the number of stock-based awards granted, the vesting period of the awards (which generally is four years), the estimated forfeiture rate, and the probable outcome of any performance conditions.


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