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TWITTER, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

August 11, 2014

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes thereto included in Item 1 "Financial Statements" in this Quarterly Report on Form 10-Q. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below and those discussed in the section titled "Risk Factors" included elsewhere in this Quarterly Report on Form 10-Q.



Overview

Twitter is a global platform for public self-expression and conversation in real time. Our platform is unique in its simplicity: Tweets are limited to 140 characters of text. This constraint makes it easy for anyone to quickly create, distribute and discover content that is consistent across our platform and optimized for mobile devices. As a result, Tweets drive a high velocity of information exchange that makes Twitter uniquely "live." We have already achieved significant global scale, and we continue to grow. We have 271 million MAUs spanning nearly every country as of the three months ended June 30, 2014. We believe the current total audience that views content on our platform, not including syndicated content, is two to three times the number of our MAUs. Our users include millions of people from around the world, as well as influential individuals and organizations. The value we create for our users is enhanced by our platform partners and advertisers. Millions of platform partners, which include publishers, media outlets and developers, have integrated with Twitter, adding value to our user experience by contributing content to our platform, broadly distributing content from our platform across their properties and using Twitter content and tools to enhance their websites and applications. In addition, advertisers use our Promoted Products to promote their brands, products and services, amplify their visibility and reach, and complement and extend the conversation around their advertising campaigns. Our revenue for the three months ended June 30, 2014 was $312.2 million, which represents a 124% increase compared to the same period last year. We generate the substantial majority of our revenue from the sale of advertising services, with the balance coming from data licensing arrangements and our mobile advertising exchange services. Mobile has become the primary driver of our business and we have been able to generate significant revenue through our mobile applications. 81% of our advertising revenue was generated from mobile devices in the three months ended June 30, 2014. 23



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Key Metrics

We review a number of metrics, including the following key metrics, to evaluate our business, measure our performance, identify trends affecting our business, formulate business plans and make strategic decisions: Monthly Active Users (MAUs). We define MAUs as Twitter users who logged in and accessed Twitter through our website, mobile website, desktop or mobile applications, SMS or registered third-party applications or websites in the 30-day period ending on the date of measurement. Average MAUs for a period represent the average of the MAUs at the end of each month during the period. In the discussion of our results of operations we compare average MAUs for the last three months of each period discussed in such comparison. MAUs are a measure of the size of our active user base. In the three months ended June 30, 2014, we had 271 million average MAUs, which represents an increase of 24% from the three months ended June 30, 2013. The growth in average MAUs was driven primarily by organic growth and product enhancements. In the three months ended June 30, 2014, we had 60 million average MAUs in the United States and 211 million average MAUs in the rest of the world, which represent increases of 21% and 25%, respectively, from the three months ended June 30, 2013. For additional information on how we calculate the number of MAUs and factors that can affect this metric, see the section titled "Note Regarding Key Metrics." [[Image Removed]] [[Image Removed]] [[Image Removed]] 24

-------------------------------------------------------------------------------- Timeline Views, Timeline Views Per MAU and Advertising Revenue Per Timeline View. We define timeline views as the total number of timelines requested when registered users visit Twitter, refresh a home timeline (but not other timelines) or view search results while logged in on our website, mobile website or desktop or mobile applications (excluding our TweetDeck and Mac clients, as we do not fully track this data). We believe that each of timeline views and timeline views per MAU are one way to measure user engagement. Timeline views per MAU are calculated by dividing the total timeline views for the period by the average MAUs for the last three months of such period. In the three months ended June 30, 2014, we had 173.2 billion timeline views, which represents an increase of 15% from the three months ended June 30, 2013. The growth in timeline views was partially due to product enhancements and certain live events like the World Cup. In the three months ended June 30, 2014, we had 47.2 billion timeline views in the United States, which represents an increase of 16% from the three months ended June 30, 2013. In the three months ended June 30, 2014, we had 126.0 billion timeline views in the rest of the world, which represents an increase of 14% from the three months ended June 30, 2013. In the three months ended June 30, 2014, we had 640 timeline views per MAU, which represents a decrease of 7% from the three months ended June 30, 2013. In the three months ended June 30, 2014, we had 792 timeline views per MAU in the United States and 596 timeline views per MAU in the rest of the world, which represent decreases of 4% and 9%, respectively, from the three months ended June 30, 2013. We anticipate that as we continue to improve Twitter to make it easier and more efficient for users to find content, the current trend of period-over-period declines in timeline views per MAUs will continue. For additional information on how we calculate the number of timeline views and factors that can affect this metric, see the section titled "Note Regarding Key Metrics." We define advertising revenue per timeline view as advertising revenue per 1,000 timeline views during the applicable period. We believe that advertising revenue per timeline view is a measure of our ability to monetize our platform. In the three months ended June 30, 2014, our advertising revenue per timeline view was $1.60, which represents a 100% increase from the three months ended June 30, 2013. In the three months ended June 30, 2014, our advertising revenue per timeline view in the United States was $3.87 and our advertising revenue per timeline view in the rest of the world was $0.75, which represent increases of 79% and 152%, respectively, from the three months ended June 30, 2013. We record advertising revenue based on the billing location of our advertisers, rather than the location of our users. [[Image Removed]] [[Image Removed]] [[Image Removed]] 25



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Non-GAAP Financial Measures

To supplement our consolidated financial statements presented in accordance with generally accepted accounting principles in the United States, or GAAP, we consider certain financial measures that are not prepared in accordance with GAAP, including Adjusted EBITDA and non-GAAP net loss. These non-GAAP financial measures are not based on any standardized methodology prescribed by GAAP and are not necessarily comparable to similarly-titled measures presented by other companies. Adjusted EBITDA



We define Adjusted EBITDA as net loss adjusted to exclude stock-based compensation expense, depreciation and amortization expense, interest and other expenses and provision (benefit) for income taxes.

The following table presents a reconciliation of net loss to Adjusted EBITDA for each of the periods indicated:

Three Months Ended June 30, Six Months Ended June 30, 2014 2013 2014 2013 (In thousands) Reconciliation of Net Loss to Adjusted EBITDA Net loss $ (144,642 )$ (42,225 )$ (277,004 )$ (69,251 ) Stock-based compensation expense 158,411 22,646 284,780 35,568 Depreciation and amortization expense 45,631 25,917 85,582 48,647 Interest and other expense, net 330 2,532 2,099 5,294 Provision (benefit) for income taxes (5,599 ) 777 (4,377 ) 1,134 Adjusted EBITDA $ 54,131$ 9,647$ 91,080$ 21,392 Non-GAAP Net Income (Loss) We define non-GAAP net income (loss) as net loss adjusted to exclude stock-based compensation expense, amortization of acquired intangible assets and the income tax effects related to acquisitions.



The following table presents a reconciliation of net loss to non-GAAP net income (loss) for each of the periods indicated:

Three Months Ended June 30, Six Months Ended June 30, 2014 2013 2014 2013 (In thousands) Reconciliation of Net Loss to Non-GAAP Net Income (Loss) Net loss $ (144,642 )$ (42,225 )$ (277,004 )$ (69,251 ) Stock-based compensation expense 158,411 22,646 284,780 35,568 Amortization of acquired intangible assets 8,099 3,302 14,275 7,178 Income tax effects related to acquisitions (7,272 ) (87 ) (7,272 ) (383 )



Non-GAAP net income (loss) $ 14,596$ (16,364 ) $

14,779 $ (26,888 ) We use the non-GAAP financial measures of Adjusted EBITDA and non-GAAP net income (loss) in evaluating our operating results and for financial and operational decision-making purposes. We believe that Adjusted EBITDA and non-GAAP net income (loss) help identify underlying trends in our business that could otherwise be masked by the effect of the expenses that we exclude in Adjusted EBITDA and non-GAAP net income (loss). We believe that Adjusted EBITDA and non-GAAP net income (loss) provide useful information about our operating results, enhance the overall understanding of our past performance and future prospects and allow for greater transparency with respect to key metrics used by our management in its financial and operational decision-making. 26 -------------------------------------------------------------------------------- These non-GAAP financial measures should not be considered in isolation from, or as a substitute for, financial information prepared in accordance with GAAP. There are a number of limitations related to the use of these non-GAAP financial measures rather than net loss, which is the nearest GAAP equivalent of these financial measures. Some of these limitations are:



These non-GAAP financial measures exclude certain recurring, non-cash

charges such as stock-based compensation expense and amortization of

acquired intangible assets;

Stock-based compensation expense has been, and will continue to be for the

foreseeable future, a significant recurring expense in our business and an

important part of our compensation strategy;

Adjusted EBITDA does not reflect tax payments that reduce cash available to us;

Adjusted EBITDA excludes depreciation and amortization expense and, although

these are non-cash charges, the property and equipment being depreciated and

amortized may have to be replaced in the future; and

The items that we exclude in our calculation of these non-GAAP financial

measures may differ from the items, if any, that our peer companies may exclude from similarly-titled non-GAAP measures when they report their results of operations.



Components of Results of Operations

Revenue

We generate the substantial majority of our revenue from the sale of advertising services. We also generate revenue by licensing our data to third parties and providing mobile advertising exchange services.



Advertising Services

We generate substantially all of our advertising revenue by selling our Promoted Products. Currently, our Promoted Products consist of the following:

Promoted Tweets. Promoted Tweets, which are labeled as "promoted," appear

within a user's timeline or search results just like an ordinary Tweet

regardless of device, whether it be desktop or mobile. Using our proprietary

algorithms, we can deliver Promoted Tweets that are intended to be relevant

to a particular user. We enable our advertisers to target an audience based

on our users' Interest Graphs, which, among other things, maps interests

based on users followed and actions taken on our platform, such as Tweets

created and engagement with Tweets. Our Promoted Tweets are

pay-for-performance advertising that are priced through an auction. We

recognize advertising revenue when a user engages with a Promoted Tweet.

Promoted Accounts. Promoted Accounts, which are labeled as "promoted," appear in the same format and place as accounts suggested by our Who to Follow recommendation engine, or in some cases, in Tweets in a user's timeline. Promoted Accounts provide a way for our advertisers to grow a community of users who are interested in their business, products or



services. Our Promoted Accounts are pay-for-performance advertising that are

priced through an auction. We recognize advertising revenue when a user follows a Promoted Account.



Promoted Trends. Promoted Trends, which are labeled as "promoted," appear at

the top of the list of trending topics for an entire day in a particular

country or on a global basis. When a user clicks on a Promoted Trend, search

results for that trend are shown in a timeline and a Promoted Tweet created

by the advertiser is displayed to the user at the top of those search

results. We sell our Promoted Trends on a fixed-fee-per-day basis. We

feature one Promoted Trend per day per geography, and recognize advertising

revenue from a Promoted Trend when it is displayed on our platform.

Data Licensing and Other

We generate data licensing and other revenue by (i) offering data licenses that allow our data partners to access, search and analyze historical and real-time data on our platform, which data consists of public Tweets and their content, and (ii) providing mobile advertising exchange services. Our data partners generally purchase licenses to access all or a portion of our data for a fixed period. 27



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Cost of Revenue and Operating Expenses

Cost of Revenue

Cost of revenue consists primarily of data center costs related to our co-located facilities, which include lease and hosting costs, related support and maintenance costs and energy and bandwidth costs, as well as depreciation of our servers and networking equipment, and personnel-related costs, including salaries, benefits and stock-based compensation, for our operations teams. Cost of revenue also includes allocated facilities and other supporting overhead costs, amortization of acquired intangible assets and capitalized labor costs. Many of the elements of our cost of revenue are relatively fixed, and cannot be reduced in the near term to offset any decline in our revenue. We plan to continue increasing the capacity and enhancing the capability and reliability of our infrastructure to support user growth and increased activity on our platform. We expect that cost of revenue will increase in dollar amount for the foreseeable future and vary in the near term from period to period as a percentage of revenue. Research and Development Research and development expenses consist primarily of personnel-related costs, including salaries, benefits and stock-based compensation, for our engineers and other employees engaged in the research and development of our products and services. In addition, research and development expenses include amortization of acquired intangible assets, allocated facilities and other supporting overhead costs. We plan to continue to hire employees for our engineering, product management and design teams to support our research and development efforts. We expect that research and development costs will increase in dollar amount for the foreseeable future and vary in the near term from period to period as a percentage of revenue.



Sales and Marketing

Sales and marketing expenses consist primarily of personnel-related costs, including salaries, benefits and stock-based compensation for our employees engaged in sales, sales support, commissions, business development and media, marketing, corporate communications and customer service functions. In addition, marketing and sales-related expenses also include market research, tradeshows, branding, marketing, public relations costs, amortization of acquired intangible assets, as well as allocated facilities and other supporting overhead costs. We plan to continue to invest in sales and marketing to expand internationally, grow our advertiser base and increase our brand awareness. We expect that sales and marketing expenses will increase in dollar amount for the foreseeable future and vary in the near term from period to period as a percentage of revenue.



General and Administrative

General and administrative expenses consist primarily of personnel-related costs, including salaries, benefits and stock-based compensation, for our executive, finance, legal, information technology, human resources and other administrative employees. In addition, general and administrative expenses include fees and costs for professional services, including consulting, third-party legal and accounting services and facilities and other supporting overhead costs that are not allocated to other departments. We plan to continue to expand our business both domestically and internationally, and expect to increase the size of our general and administrative function to help grow our business. We expect that we will incur additional general and administrative expenses as a result of being a newly-public company. We expect that general and administrative expenses will increase in dollar amount for the foreseeable future and vary in the near term from period to period as a percentage of revenue.



Provision (Benefit) for Income Taxes

Provision for income taxes consists of federal and state income taxes in the United States and income taxes in certain foreign jurisdictions, and deferred income taxes and changes in related valuation allowance reflecting the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. 28



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Results of Operations

The following tables set forth our consolidated statement of operations data for each of the periods presented:

Three Months Ended June 30, Six Months Ended June 30, 2014 2013 2014 2013 (in thousands) Revenue Advertising services $ 277,440$ 120,972$ 503,491$ 221,432 Data licensing and other 34,726 18,320 59,167 32,203 Total Revenue 312,166 139,292 562,658 253,635 Costs and expenses (1) Cost of revenue 100,027 50,573 185,530 91,828 Research and development 177,095 64,263 326,486 111,837 Sales and marketing 140,261 45,258 246,496 77,697 General and administrative 44,694 18,114 83,428 35,096 Total costs and expenses 462,077 178,208 841,940 316,458 Loss from operations (149,911 ) (38,916 ) (279,282 ) (62,823 ) Interest income (expense), net (2,110 ) (1,513 ) (4,677 ) (2,746 ) Other income (expense), net 1,780 (1,019 ) 2,578 (2,548 ) Loss before income taxes (150,241 ) (41,448 ) (281,381 ) (68,117 ) Provision (benefit) for income taxes (5,599 ) 777 (4,377 ) 1,134 Net loss $ (144,642 )$ (42,225 )$ (277,004 )$ (69,251 ) (1) Costs and expenses include stock-based compensation expense as follows (in thousands): Three Months Ended June 30, Six Months Ended June 30, 2014 2013 2014 2013 Cost of revenue $ 13,869$ 1,471$ 23,700$ 1,955 Research and development 92,493 15,772 170,811 24,197 Sales and marketing 37,547 2,549 65,348 4,614 General and administrative 14,502 2,854 24,921 4,802 Total $ 158,411$ 22,646$ 284,780$ 35,568



The following table sets forth our consolidated statement of operations data for each of the periods presented as a percentage of revenue:

Three Months Ended June 30, Six Months Ended June 30, 2014 2013 2014 2013 Revenue Advertising services 89 % 87 % 89 % 87 % Data licensing and other 11 13 11 13 Total Revenue 100 100 100 100 Costs and expenses Cost of revenue 32 36 33 36 Research and development 57 46 58 44 Sales and marketing 45 32 44 31 General and administrative 14 13 15 14 Total costs and expenses 148 128 150 125 Loss from operations (48 ) (28 ) (50 ) (25 ) Interest income (expense), net (1 ) (1 ) (1 ) (1 ) Other income (expense), net 1 (1 ) 0 (1 ) Loss before income taxes (48 ) (30 ) (50 ) (27 ) Provision (benefit) for income taxes (2 ) 1 (1 ) 0 Net loss (46 )% (30 )% (49 )% (27 )% 29



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Revenue Three Months Ended June 30, Six Months Ended June 30, 2014 2013 % Change 2014 2013 % Change (in thousands) (in thousands)

Advertising services $ 277,440$ 120,972 129 % $ 503,491$ 221,432 127 % Data licensing and other 34,726 18,320 90 % 59,167 32,203 84 % Total revenue $ 312,166$ 139,292 124 % $ 562,658$ 253,635 122 %



Revenue in the three and six months ended June 30, 2014 increased by $172.9 million and $309.0 million compared to the three and six months ended June 30, 2013, respectively.

In the three and six months ended June 30, 2014, advertising revenue increased by 129% and 127% compared to the three and six months ended June 30, 2013, respectively. The increase was primarily attributable to a 15% increase in timeline views in both the three and six months ended June 30, 2014 compared to the same periods in 2013, as well as an increase in demand from advertisers that drove an increase in advertising revenue per timeline view of 100% and 98% in the three and six months ended June 30, 2014 compared to the same periods in 2013, respectively. The increase in timeline views was driven by a 24% increase in average MAUs partially offset by a 7% decrease in the user engagement levels of MAUs, as measured by timeline views per MAU, in both the three and six months ended June 30, 2014 compared to the same periods in 2013. The increase in advertising revenue per timeline view was primarily driven by a 210% and 312% increase in ad engagements per timeline view, partially offset by a 35% and 52% decrease in average cost per ad engagement in the three and six months ended June 30, 2014 compared to the same periods in 2013, respectively. The increase in ad engagements per timeline view, combined with the increase in timeline views, resulted in a 255% and 374% increase in the number of ad engagements in the three and six months ended June 30, 2014 compared to the same periods in 2013, respectively. Advertising revenue also benefited from sales of our Promoted Products on our mobile applications as well as from an increase in international revenue in both the three and six months ended June 30, 2014 as compared to the same periods in 2013. In the three and six months ended June 30, 2014, data licensing and other revenue increased by 90% and 84% compared to the three and six months ended June 30, 2013, respectively. A substantial majority of the increase was attributable to mobile advertising exchange services. Cost of Revenue Three Months Ended June 30, Six Months Ended June 30, 2014 2013 % Change 2014 2013 % Change (in thousands) (in thousands) Cost of revenue $ 100,027$ 50,573 98 % $ 185,530$ 91,828 102 % Cost of revenue as a percentage of revenue 32 % 36 % 33 % 36 % In the three months ended June 30, 2014, cost of revenue increased by $49.5 million compared to the three months ended June 30, 2013. The increase was primarily attributable to a $17.7 million increase in personnel-related costs, mainly driven by an increase in average employee headcount and recognition of stock-based compensation expense, a $13.9 million increase in data center costs, networking and hosting related to our co-located facilities, a $14.5 million increase in depreciation expense related to capital leases for additional server and networking equipment, and a $3.4 million increase in allocated facilities and other supporting overhead costs due to the continued expansion of our real estate footprint and increase in support functions. In the six months ended June 30, 2014, cost of revenue increased by $93.7 million compared to the six months ended June 30, 2013. The increase was primarily attributable to a $32.2 million increase in personnel-related costs, mainly driven by an increase in average employee headcount and recognition of stock-based compensation expense, a $27.2 million increase in data center costs, networking and hosting related to our co-located facilities, a $27.7 million increase in depreciation expense related to capital leases for additional server and networking equipment, and a $6.6 million increase in allocated facilities and other supporting overhead costs due to the continued expansion of our real estate footprint and increase in support functions. 30



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Research and Development Three Months Ended June 30, Six Months Ended June 30, 2014 2013 % Change 2014 2013 % Change (in thousands) (in thousands)



Research and development $ 177,095$ 64,263

176 % $ 326,486$ 111,837 192 % Research and development as a percentage of revenue 57 % 46 % 58 % 44 % In the three months ended June 30, 2014, research and development expenses increased by $112.8 million compared to the three months ended June 30, 2013. The increase was primarily attributable to a $114.4 million increase in personnel-related costs, mainly driven by an increase in average employee headcount and recognition of stock-based compensation expense, and a $8.8 million increase in allocated facilities and other supporting overhead expenses due to the continued expansion of our real estate footprint and increase in support functions. These increases were partially offset by a $10.4 million increase in capitalized costs associated with developing software for internal use. In the six months ended June 30, 2014, research and development expenses increased by $214.6 million compared to the six months ended June 30, 2013. The increase was primarily attributable to a $213.9 million increase in personnel-related costs, mainly driven by an increase in average employee headcount and recognition of stock-based compensation expense, and a $18.7 million increase in allocated facilities and other supporting overhead expenses due to the continued expansion of our real estate footprint and increase in support functions. These increases were partially offset by a $18.0 million increase in capitalized costs associated with developing software for internal use. Sales and Marketing Three Months Ended June 30, Six Months Ended June 30, 2014 2013 % Change 2014 2013 % Change (in thousands) (in thousands)

Sales and marketing $ 140,261$ 45,258 210 % $ 246,496$ 77,697 217 % Sales and marketing as a percentage of revenue 45 % 32 % 44 % 31 % In the three months ended June 30, 2014, sales and marketing expenses increased by $95.0 million compared to the three months ended June 30, 2013. The increase was primarily attributable to a $63.7 million increase in personnel-related costs, mainly driven by an increase in average employee headcount and recognition of stock-based compensation expense, a $19.5 million increase in marketing and sales-related expenses and a $11.8 million increase in allocated facilities and other supporting overhead expenses due to the continued expansion of our real estate footprint and increase in support functions. In the six months ended June 30, 2014, sales and marketing expenses increased by $168.8 million compared to the six months ended June 30, 2013. The increase was primarily attributable to a $116.3 million increase in personnel-related costs, mainly driven by an increase in average employee headcount and recognition of stock-based compensation expense, a $30.1 million increase in marketing and sales-related expenses and a $22.4 million increase in allocated facilities and other supporting overhead expenses due to the continued expansion of our real estate footprint and increase in support functions. General and Administrative Three Months Ended June 30, Six Months Ended June 30, 2014 2013 % Change 2014 2013 % Change (in thousands) (in thousands)

General and administrative $ 44,694$ 18,114 147 % $ 83,428$ 35,096 138 % General and administrative as a percentage of revenue 14 % 13 % 15 % 14 % 31

-------------------------------------------------------------------------------- In the three months ended June 30, 2014, general and administrative expense increased by $26.6 million compared to the three months ended June 30, 2013. The increase was primarily attributable to a $24.6 million increase in personnel-related costs, mainly driven by an increase in average employee headcount and recognition of stock-based compensation expense and an increase of $3.9 million in fees and costs for professional services, partially offset by a $1.9 million decrease in unallocated facilities and other supporting costs, driven by slower headcount growth in the general and administrative function relative to other functional areas. In the six months ended June 30, 2014, general and administrative expenses increased by $48.3 million compared to the six months ended June 30, 2013. The increase was primarily attributable to a $42.7 million increase in personnel-related costs, mainly driven by an increase in average employee headcount and recognition of stock-based compensation expense and an increase of $7.2 million in fees and costs of professional services, partially offset by a $1.6 million decrease in unallocated facilities and supporting costs, driven by slower headcount growth in the general and administrative function relative to other functional areas.



Provision (Benefit) for Income Taxes

Three Months Ended June 30, Six Months Ended June 30, 2014 2013 2014 2013 (in thousands) (in thousands) Provision (benefit) for income taxes $ (5,599 ) $ 777$ (4,377 )$ 1,134 Our benefit for income taxes in the three and six months ended June 30, 2014 increased by $6.4 million and $5.5 million, respectively, compared to a provision of $0.8 million and $1.1 million in the three and six months ended June 30, 2013, respectively. The increase was primarily due to the deferred tax benefits arising from acquisitions, partially offset by the increase in foreign and state income tax expenses.


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