10-Q 1 form10q.htm Unassociated Document

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 
FORM 10-Q
 
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 
For the quarterly period ended SEPTEMBER 30, 2004
 
or
 
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 
For the transition period from ____________________ to ____________________
 
Commission file number: 0-30141
 
LIVEPERSON, INC.
(Exact Name of Registrant as Specified in Its Charter)

DELAWARE
 
13-3861628
(State or Other Jurisdiction of Incorporation or Organization)
 
(IRS Employer Identification No.)

462 SEVENTH AVENUE, 21ST FLOOR
NEW YORK, NEW YORK
 
10018
(Address of Principal Executive Offices)
 
(Zip Code)

(212) 609-4200
(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
Yes x No o
 
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
 
Yes o No x
 
As of November 1, 2004, there were 37,371,482 shares of the issuer’s common stock outstanding.
 
     



LIVEPERSON, INC.
SEPTEMBER 30, 2004
FORM 10-Q
INDEX

 

 PAGE

PART I. FINANCIAL INFORMATION
3
   
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
3
   
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS AS OF SEPTEMBER 30, 2004 AND DECEMBER 31, 2003
3
   
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
4
   
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
5
   
NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
6
   
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
13
   
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
30
   
ITEM 4. CONTROLS AND PROCEDURES
31
   
PART II. OTHER INFORMATION
31
   
ITEM 1. LEGAL PROCEEDINGS
31
   
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
31
   
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
31
   
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
32
   
ITEM 5. OTHER INFORMATION
32
   
ITEM 6. EXHIBITS
32

  2  

 

FORWARD-LOOKING STATEMENTS

STATEMENTS IN THIS REPORT ABOUT LIVEPERSON, INC. THAT ARE NOT HISTORICAL FACTS ARE FORWARD-LOOKING STATEMENTS BASED ON OUR CURRENT EXPECTATIONS, ASSUMPTIONS, ESTIMATES AND PROJECTIONS ABOUT LIVEPERSON AND OUR INDUSTRY. THESE FORWARD-LOOKING STATEMENTS ARE SUBJECT TO RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL FUTURE EVENTS OR RESULTS TO DIFFER MATERIALLY FROM SUCH STATEMENTS. ANY SUCH FORWARD-LOOKING STATEMENTS ARE MADE PURSUANT TO THE SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. IT IS ROUTINE FOR OUR INTERNAL PROJECTIONS AND EXPECTATIONS TO CHANGE AS THE YEAR OR EACH QUARTER IN THE YEAR PROGRESS, AND THEREFORE IT SHOULD BE CLEARLY UNDERSTOOD THAT THE INTERNAL PROJECTIONS AND BELIEFS UPON WHICH WE BASE OUR EXPECTATIONS MAY CHANGE PRIOR TO THE END OF EACH QUARTER OR THE YEAR. ALTHOUGH THESE EXPECTATIONS MAY CHANGE, WE ARE UNDER NO OBLIGATION TO INFORM YOU IF THEY DO. OUR COMPANY POLICY IS GENERALLY TO PROVIDE OUR EXPECTATIONS ONLY ONCE PER QUARTER, AND NOT TO UPDATE THAT INFORMATION UNTIL THE NEXT QUARTER. ACTUAL EVENTS OR RESULTS MAY DIFFER MATERIALLY FROM THOSE CONTAINED IN THE PROJECTIONS OR FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE THOSE DISCUSSED IN THE SECTION CAPTIONED “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS—RISK FACTORS THAT MAY AFFECT FUTURE RESULTS.”
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 

  3  

 

PART I. FINANCIAL INFORMATION
 
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
LIVEPERSON, INC.
 
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
 
UNAUDITED
 
   
September 30,
2004
 
December 31,
2003
 
ASSETS
             
Current assets:
             
Cash and cash equivalents
 
$
12,287
 
$
10,898
 
Accounts receivable, net of allowances for doubtful accounts of $79 and $64 as of September 30, 2004 and December 31, 2003, respectively
   
1,088
   
1,239
 
Prepaid expenses and other current assets
   
518
   
318
 
Total current assets
   
13,893
   
12,455
 
Property and equipment, net
   
462
   
341
 
Intangibles, net
   
1,950
   
361
 
Security deposits
   
137
   
129
 
Other assets
   
312
   
251
 
Total assets
 
$
16,754
 
$
13,537
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
             
Current liabilities:
             
Accounts payable
 
$
284
 
$
116
 
Accrued expenses
   
1,957
   
2,577
 
Deferred revenue
   
1,054
   
1,276
 
Total current liabilities
   
3,295
   
3,969
 
Other liabilities
   
312
   
232
 
               
Commitments and contingencies
             
Stockholders’ equity:
             
Preferred stock, $.001 par value per share; 5,000,000 shares authorized, 0 shares issued and outstanding at September 30, 2004 and December 31, 2003
   
--
   
--
 
Common stock, $.001 par value per share; 100,000,000 shares authorized, 37,347,107 shares issued and outstanding at September 30, 2004 and 36,816,415 shares issued and outstanding at December 31, 2003
   
37
   
36
 
Additional paid-in capital
   
117,406
   
115,315
 
Deferred compensation
   
(59
)
 
--
 
Accumulated deficit
   
(104,237
)
 
(106,015
)
Total stockholders’ equity
   
13,147
   
9,336
 
Total liabilities and stockholders’ equity
 
$
16,754
 
$
13,537
 
 

 
SEE ACCOMPANYING NOTES TO UNAUDITED INTERIM CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS.

  4  

 

LIVEPERSON, INC.
 
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
UNAUDITED
 
     
Three Months Ended
September 30, 
   
Nine Months Ended
September 30, 
 
     
2004 

 

 

2003 

 

 

2004 

 

 

2003 
 
Revenue
 
$
4,381
 
$
3,142
 
$
12,796
 
$
8,497
 
Operating expenses:
                         
Cost of revenue
   
730
   
501
   
2,116
   
1,508
 
Product development expense
   
515
   
419
   
1,470
   
1,170
 
Sales and marketing expense
   
1,327
   
910
   
3,721
   
2,494
 
General and administrative expense
   
1,222
   
1,059
   
3,131
   
2,655
 
Amortization of intangibles
   
204
   
253
   
563
   
760
 
Restructuring charge
   
--
   
--
   
--
   
1,024
 
Total operating expenses
   
3,998
   
3,142
   
11,001
   
9,611
 
Income (loss) from operations
   
383
   
--
   
1,795
   
(1,114
)
Other income (expense):
                         
Other expense
   
--
   
--
   
--
   
(8
)
Interest income
   
18
   
9
   
41
   
28
 
Total other income, net
   
18
   
9
   
41
   
20
 
Income (loss) before provision for income taxes
   
401
   
9
   
1,836
   
(1,094
)
Provision for income taxes
   
25
   
--
   
58
   
--
 
Net income (loss)
 
$
376
 
$
9
 
$
1,778
 
$
(1,094
)
                           
Basic net income (loss) per share
 
$
0.01
 
$
0.00
 
$
0.05
 
$
(0.03
)
Diluted net income (loss) per share
 
$
0.01
 
$
0.00
 
$
0.05
 
$
(0.03
)
Weighted average shares outstanding used in basic net income (loss) per share calculation
   
37,336,792
   
34,887,114
   
37,222,428
   
34,426,751
 
Weighted average shares outstanding used in diluted net income (loss) per share calculation
   
37,336,792
   
35,668,024
   
37,770,159
   
34,426,751
 
 

 
SEE ACCOMPANYING NOTES TO UNAUDITED INTERIM CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS.LIVEPERSON, INC.
 

  5  

 

 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
UNAUDITED
   
Nine Months Ended
September 30,
 
   
2004
 
2003
 
CASH FLOWS FROM OPERATING ACTIVITIES:
             
Net income (loss)
 
$
1,778
 
$
(1,094
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
             
Non-cash compensation expense, net
   
187
   
191
 
Depreciation
   
172
   
281
 
Amortization of intangibles
   
563
   
760
 
Provision for doubtful accounts, net
   
15
   
15
 
               
CHANGES IN OPERATING ASSETS AND LIABILITIES:
             
Accounts receivable
   
33
   
123
 
Prepaid expenses and other current assets
   
(200
)
 
(102
)
Security deposits
   
(8
)
 
(4
)
Accounts payable
   
168
   
(30
)
Accrued expenses
   
(713
)
 
544
 
Deferred revenue
   
(222
)
 
239
 
Other assets and other liabilities, net
   
19
   
--
 
Net cash provided by operating activities
   
1,792
   
923
 
               
CASH FLOWS FROM INVESTING ACTIVITIES:
             
Purchases of property and equipment, including capitalized software
   
(293
)
 
(32
)
Acquisition costs
   
(206
)
 
--
 
Net cash used in investing activities
   
(499
)
 
(32
)
               
CASH FLOWS FROM FINANCING ACTIVITIES:
             
Proceeds from issuance of common stock in connection with the exercise of options
   
96
   
741
 
Net cash provided by financing activities
   
96
   
741
 
Effect of foreign exchange rate changes on cash and cash equivalents
   
--
   
8
 
Net increase in cash and cash equivalents
   
1,389
   
1,640
 
Cash and cash equivalents at the beginning of the period
   
10,898
   
8,004
 
Cash and cash equivalents at the end of the period
 
$
12,287
 
$
9,644
 

Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for:
 Income taxes
   
51
   
--
 

Supplemental Disclosure of Non-cash Investing Activities:

During the nine months ended September 30, 2004, the Company issued 370,894 shares of common stock in connection with the acquisition of certain identifiable assets of Island Data Corporation.

 
SEE ACCOMPANYING NOTES TO UNAUDITED INTERIM CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS.

 

 
  6  



LIVEPERSON, INC.
 
NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
 
(1) SUMMARY OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
 
(A) SUMMARY OF OPERATIONS
 
LivePerson, Inc. (the “Company” or “LivePerson”) was incorporated in the State of Delaware in 1995. The Company commenced operations in 1996. The Company is a provider of communications solutions for online sales, marketing and customer service. LivePerson’s Timpani software platform enables online businesses to identify and engage website visitors with the appropriate communication channel, thereby enhancing the online experience. Chat, marketing and selling tools, a self-service knowledgebase and email management are combined with channel matching technology, rules-based intelligence, routing and reporting to enable clients to increase sales, lower customer service costs and enhance the customer experience.
 
The Company’s primary revenue source is from the sale of the LivePerson services under the brand name Timpani, which is conducted within one operating segment. The Company’s product development staff, help desk and online sales support are located in Israel.
 
(B) UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL INFORMATION
 
The accompanying interim condensed consolidated financial statements as of September 30, 2004 and for the nine months ended September 30, 2004 and 2003 are unaudited. In the opinion of management, the unaudited interim condensed consolidated financial statements have been prepared on the same basis as the annual financial statements and reflect all adjustments, which include only normal recurring adjustments, necessary to present fairly the condensed consolidated financial position of LivePerson as of September 30, 2004, and the consolidated results of operations and cash flows for the interim periods ended September 30, 2004 and 2003. The financial data and other information disclosed in these notes to the condensed consolidated financial statements related to these periods are unaudited. The results of operations for any interim period are not necessarily indicative of the results of operations for any other future interim period or for a full fiscal year. The condensed consolidated balance sheet at December 31, 2003 has been derived from audited consolidated financial statements at that date.
 
Certain information and note disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). These unaudited interim condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto for the year ended December 31, 2003, included in the Company’s Annual Report on Form 10-K filed with the SEC on March 29, 2004.
 
(C) REVENUE RECOGNITION
 
LivePerson’s Timpani facilitates real-time sales, marketing and customer service for companies that conduct business online. The Timpani product line includes: Timpani Contact Center for customer service; Timpani Sales & Marketing for proactive online engagement; and Timpani SB for small business customer support. The Company charges a monthly fee, which varies by service. Certain of the Company’s larger clients, who require more sophisticated implementation and training, may also pay an initial non-refundable set-up fee and professional service fees related to training and implementation.
 
The initial set-up fee is intended to recover certain costs (principally customer service, training and other administrative costs) prior to the deployment of the LivePerson services. Such fees are recorded as deferred revenue and recognized ratably over a period of 24 months, representing the estimated term of the client relationships. Although the Company believes this estimate is reasonable, this estimate may change in the future. In instances where the Company does charge a set-up fee, the Company typically does not charge an additional set-up fee if an existing client adds more services. Unamortized deferred fees, if any, are recognized upon termination of the agreement with the customer. The Company recognized $0 and $2 in the three and nine months ended September 30, 2004 and $0 and $0 in the three and nine months ended September 30, 2003, respectively, of set-up fees due to client attrition.
 

 
  7  

 

The Company also sells certain of the LivePerson Timpani services directly via Internet download. These services are marketed as Timpani SB for small- and medium-sized businesses, and are paid for almost exclusively by credit card. Credit card payments accelerate cash flow and reduce the Company’s collection risk, subject to the merchant bank’s right to hold back cash pending settlement of the transactions. Sales executed via Internet download may occur with or without the assistance of an online sales representative, rather than through face-to-face or telephone contact that is typically required for traditional direct sales. Sales of the LivePerson services via Internet download typically have no set-up fee, because the Company does not provide the customer with training and administrative costs are minimal.
 
The Company records revenue for its traditional direct sales and Internet download sales based upon a monthly fee charged for the LivePerson services, provided that no significant Company obligations remain and collection of the resulting receivable is probable. The Company recognizes monthly service revenue fees as services are provided. The Company’s service agreements typically have no termination date and are terminable by either party upon 30 to 90 days’ notice without penalty. The Company recognizes professional service fees upon completion and customer acceptance of the professional service engagement.
 
(D) STOCK-BASED COMPENSATION
 
The Company applies the intrinsic value-based method of accounting prescribed by Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations including Financial Accounting Standards Board (“FASB”) Interpretation No. 44, “Accounting for Certain Transactions Involving Stock Compensation: An Interpretation of APB Opinion No. 25,” to account for its fixed plan stock options. Under this method, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” established accounting and disclosure requirements using a fair value-based method of accounting for stock-based employee compensation plans. As allowed by SFAS No. 123, the Company has elected to continue to apply the intrinsic value-based method of accounting described above, and has adopted the disclosure requirements of SFAS No. 123. The Company amortizes deferred compensation on a graded vesting methodology in accordance with FASB Interpretation No. 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Award Plans.”
 
The Company applies APB Opinion No. 25 and related interpretations in accounting for its stock option grants to employees. Accordingly, except as mentioned below, no compensation expense has been recognized relating to these stock option grants in the consolidated financial statements. Had compensation cost for the Company’s stock option grants been determined based on the fair value at the grant date for awards consistent with the method of SFAS No. 123, the Company’s net income attributable to common stockholders for the three and nine months ended September 30, 2004 and the three months ended September 30, 2003 would have decreased and the net loss attributable to common stockholders for the nine months ended September 30, 2003 would have increased to the pro forma amounts presented below. The Company did not have any employee stock options outstanding prior to January 1, 1998.
 
The Company determined after the end of the second quarter of 2004 that it had misapplied certain provisions of SFAS No. 123 when calculating the disclosure requirements for its stock-based employee compensation plan using a fair-value based method of accounting. The misapplication primarily related to the amortization period used when computing the pro forma compensation expense impact of issued stock options on net income (loss) and basic and diluted net income (loss) per common share. The Company has restated the originally disclosed pro forma amounts for each of the three-month periods beginning with the three months ended March 31, 2003 and ending with the three months ended March 31, 2004. The restated pro forma amounts do not affect our reported results of operations for any period. The table below includes the restated pro forma amounts for the three and nine month periods ended September 30, 2003.
 

 
  8  

 

   
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
   
2004
 
2003
(Restated)
 
2004
 
2003
(Restated)
 
Net income (loss) as reported
 
$
376
 
$
9
 
$
1,778
 
$
(1,094
)
Add: Stock-based compensation expense included in net income (loss) as reported
 
$
--
 
$
143
 
$
--
 
$
191
 
Deduct: Pro forma stock-based compensation cost
 
$
(304
)
$
(243
)
$
(943
)
$
(690
)
Pro forma net income (loss)
 
$
72
 
$
(91
)
$
835
 
$
(1,593
)
Basic net income (loss) per common share:
                         
As reported
 
$
0.01
 
$
0.00
 
$
0.05
 
$
(0.03
)
Pro forma
 
$
0.00
 
$
(0.00
)
$
0.02
 
$
(0.05
)
Diluted net income (loss) per common share:
                   
As reported
 
$
0.01
 
$
0.00
 
$
0.05
 
$
(0.03
)
Pro forma
 
$
0.00
 
$
(0.00
)
$
0.02
 
$
(0.05
)
 
The per share weighted average fair value of stock options granted during the nine months ended September 30, 2004 and 2003, was $2.47 and $1.33, respectively. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions used for grants in 2004 and 2003: dividend yield of zero percent for all periods; risk-free interest rates of 4.6% and 4.1%, respectively; and expected life of five years for all periods. During 2004 and 2003, the Company used a volatility factor of 90.59% and 146.36%, respectively.
 
The following tables provide the restated pro forma amounts of originally reported 2003 and 2004 pro forma disclosures. The Company has disclosed, and intends to continue to disclose in future filings, the restated amounts for such pro forma disclosures.
 
Pro forma stock-based compensation cost:
 
Period
 
Previously Disclosed
in Original Report
 
Restated
 
Three Months Ended March 31, 2003
 
$
(16
)
$
(220
)
Three Months Ended June 30, 2003
 
$
(296
)
$
(227
)
Six Months Ended June 30, 2003
 
$
(312
)
$
(447
)
Three Months Ended September 30, 2003
 
$
(1,043
)
$
(243
)
Nine Months Ended September 30, 2003
 
$
(1,355
)
$
(690
)
Year Ended December 31, 2003
 
$
(403
)
$
(945
)
Three Months Ended March 31, 2004
 
$
(617
)
$
(300
)
 
Pro forma net income (loss):
 
Period
 
Previously Disclosed
in Original Report
 
Restated
 
Three Months Ended March 31, 2003
 
$
(93
)
$
(303
)
Three Months Ended June 30, 2003
 
$
(1,274
)
$
(1,205
)
Six Months Ended June 30, 2003
 
$
(1,367
)
$
(1,502
)
Three Months Ended September 30, 2003
 
$
(891
)
$
(91
)
Nine Months Ended September 30, 2003
 
$
(2,258
)
$
(1,593
)
Year Ended December 31, 2003
 
$
(1,174
)
$
(1,716
)
Three Months Ended March 31, 2004
 
$
82
 
$
399
 

  9  

 

 
Pro forma basic net income (loss) per common share:
 
Period
 
Previously Disclosed
in Original Report
 
Restated
 
Three Months Ended March 31, 2003
 
$
(0.00
)
$
(0.01
)
Three Months Ended June 30, 2003
 
$
(0.04
)
$
(0.04
)
Six Months Ended June 30, 2003
 
$
(0.04
)
$
(0.04
)
Three Months Ended September 30, 2003
 
$
(0.03
)
$
(0.00
)
Nine Months Ended September 30, 2003
 
$
(0.06
)
$
(0.05
)
Year Ended December 31, 2003
 
$
(0.03
)
$
(0.05
)
Three Months Ended March 31, 2004
 
$
0.00
 
$
0.01
 
 
Pro forma diluted net income (loss) per common share:
 
Period
 
Previously Disclosed
in Original Report
 
Restated
 
Three Months Ended March 31, 2003
 
$
(0.00
)
$
(0.01
)
Three Months Ended June 30, 2003
 
$
(0.04
)
$
(0.04
)
Six Months Ended June 30, 2003
 
$
(0.04
)
$
(0.04
)
Three Months Ended September 30, 2003
 
$
(0.03
)
$
(0.00
)
Nine Months Ended September 30, 2003
 
$
(0.06
)
$
(0.05
)
Year Ended December 31, 2003
 
$
(0.03
)
$
(0.05
)
Three Months Ended March 31, 2004
 
$
0.00
 
$
0.01
 

 
(E) BASIC AND DILUTED NET INCOME (LOSS) PER SHARE
 
The Company calculates earnings per share in accordance with the provisions of SFAS No. 128, “Earnings Per Share (“EPS”),” and SEC Staff Accounting Bulletin (“SAB”) No. 98. Under SFAS No. 128, basic EPS excludes dilution for common stock equivalents and is computed by dividing net income or loss attributable to common shareholders by the weighted average number of common shares outstanding for the period. All options, warrants or other potentially dilutive instruments issued for nominal consideration are required to be included in the calculation of basic and diluted net loss attributable to common stockholders. The Company has included 17,339 shares of common stock in the calculation of basic and diluted net income (loss) attributable to common stockholders from October 2000 which relate to certain options that were originally issued by HumanClick Ltd. for nominal consideration and subsequently assumed by the Company in connection with its acquisition of HumanClick in October 2000. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock and resulted in the issuance of common stock. Diluted net income (loss) per share presented is equal to basic net income (loss) per share since all common stock equivalents are anti-dilutive for the three months ended September 30, 2004 and the nine months ended September 30, 2003.
 
Diluted net income per common share for the nine month period ended September 30, 2004 and the three month period ended September 30, 2003 include the effect of options to purchase 5,702,150 and 6,243,489 shares of common stock with a weighted average exercise price of $1.20 and $0.85, respectively, and warrants to purchase 202,802 and 431,249 shares of common stock with a weighted average exercise price of $1.65 and $1.28, respectively. Diluted net loss per common share for the three month period ended September 30, 2004 and the nine month period September 30, 2003 does not include the effect of options to purchase 5,349,650 and 5,166,092 shares of common stock, respectively, and warrants to purchase 127,802 and 431,249 shares of common stock, respectively, as the effect of their inclusion is anti-dilutive during each period.
 

 
  10  

 

(F) RECENT ACCOUNTING PRONOUNCEMENTS
 
In March 2004, the FASB issued for exposure a Proposed Statement of Financial Accounting Standards entitled “Share-Based Payment - an Amendment of SFAS Nos. 123 and 95.” The proposal requires that the fair value of employee stock-based compensation be expensed. Although the proposal differs from SFAS No. 123, as amended by SFAS No. 148, its requirements will only apply to new grants of stock or options to employees. The Company will continue to monitor the progress of the FASB with regard to the final requirements of this new standard.
 
FASB Interpretation No. 46, “Consolidation of Variable Interest Entities - An Interpretation of APB No. 51,” as amended by FASB Interpretation No. 46R, is effective in 2004. FASB Interpretation No. 46 addresses the consolidation by business enterprises of variable interest entities, as defined in the interpretation, and is based on the concept that companies that control another entity through interests, other than voting interests, should consolidate the controlled entity. The FASB subsequently issued Interpretation No. 46R in December 2003, which modified certain provisions of FASB Interpretation No. 46, and which must be applied to the first reporting period after March 15, 2004. FASB Interpretation No. 46, as amended by FASB Interpretation No. 46R, did not have an impact on the Company’s financial position, cash flows or results of operations, or result in additional disclosure in the Company’s financial statements.
 
In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity.” SFAS No. 150 established standards for the classification and measurement of certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 also includes required disclosures for financial instruments within its scope. For the Company, SFAS No. 150 was effective for instruments entered into or modified after May 31, 2003 and otherwise was effective as of January 1, 2004, except for mandatorily redeemable financial instruments. For these mandatorily redeemable financial instruments, SFAS No. 150 will be effective for the Company on January 1, 2005. The effective date has been deferred indefinitely for certain other types of mandatorily redeemable financial instruments. The Company does not have any financial instruments that are within the scope of SFAS No. 150; therefore the issuance of SFAS No. 150 did not have an impact on the Company’s financial position, cash flows or results of operations.
 
In December 2003, the staff of the SEC issued SAB No. 104, “Revenue Recognition,” which supersedes SAB No. 101, “Revenue Recognition in Financial Statements.” SAB No. 104 primarily rescinds the accounting guidance contained in SAB No. 101 related to multiple-element revenue arrangements, which was superseded as a result of the issuance of Emerging Issues Task Force Issue No. 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.” Additionally, SAB No. 104 rescinds the SEC’s “Revenue Recognition in Financial Statements Frequently Asked Questions and Answers” issued with SAB No. 101, which had been codified in SEC Topic 13, “Revenue Recognition.” SAB No. 104 was effective upon issuance. The issuance of SAB No. 104 did not have any impact on the Company’s financial position, cash flows or results of operations.
 
(2) BALANCE SHEET COMPONENTS
 
Property and equipment is summarized as follows:
 
   
September 30,
2004
 
December 31,
2003
 
Computer equipment and software
 
$
1,746
 
$
1,460
 
Furniture, equipment and building improvements
   
43
   
36
 
     
1,789
   
1,496
 
Less accumulated depreciation
   
1,327
   
1,155
 
Total
 
$
462
 
$
341
 


 
  11  

 

Accrued expenses consist of the following:
 
   
September 30,
2004
 
December 31,
2003
 
Professional services and consulting fees
 
$
483
 
$
382
 
Payroll and related costs
   
944
   
1,820
 
Legal settlement (a)
   
250
   
--
 
Sales commissions
   
50
   
31
 
Acquisition costs
   
93
   
286
 
Other
   
137
   
58
 
Total
 
$
1,957
 
$
2,577
 

(a) In the three months ended September 30, 2004, the Company recorded a charge of $250 related to the settlement of a previously disclosed legal proceeding (see Note 5). Because the Company’s September 30, 2004 interim financial statements were not yet filed with the SEC when the Company entered into the settlement in November 2004, the recording of this charge in the three months ended September 30, 2004 was required pursuant to generally accepted accounting principles.

(3) ASSET ACQUISITIONS
 
In July 2004, the Company acquired certain identifiable assets of FaceTime Communications, Inc. (“FaceTime”). The transaction transferred certain existing customer contracts of FaceTime to the Company. The purchase price was based in part on future revenue generated by the Company from the former FaceTime client base. As of September 30, 2004, the Company incurred total transaction costs of approximately $394, which included the initial purchase price payment of $200 to FaceTime. The Company expects the total cost of the transaction to be less than $400. The total acquisition cost will be amortized ratably over a period of 24 months, representing the Company’s current estimate of the term of the acquired client relationships. The net acquisition costs of $369 are included in “Assets - Other intangibles, net” on the Company’s September 30, 2004 balance sheet.
 
In December 2003, the Company acquired certain identifiable assets of Island Data Corporation (“Island Data”). The purchase price was based on projected revenue from the acquired customer contracts at the time of their assignment to the Company. As of September 30, 2004, the Company paid approximately $370 in cash, and issued 370,894 shares of common stock, in connection with the acquisition. The total acquisition costs were approximately $2,119. Of the total purchase price, the Company has allocated approximately $65 to non-compete agreements which will be amortized over a period of 24 months, representing the terms of the agreements. The remainder of the purchase price has been allocated to customer contracts and will be amortized over a period of 36 months, representing the Company’s current estimate of the term of the acquired client relationships. The net acquisition costs of $1,581 are included in “Assets - Other intangibles, net” on the Company’s September 30, 2004 balance sheet.
 
In January 2004, the Company filed a registration statement with the SEC to register the resale of up to 500,000 shares of its common stock by Island Data. The Company’s registration of the resale of the shares was required by its agreement with Island Data. The shares registered for resale on the registration statement, but not actually issued to Island Data pursuant to the agreement, will be deregistered. The Company will not receive any proceeds from the sale of the shares of common stock covered by the Island Data registration statement.
 
(4) COMMITMENTS AND CONTINGENCIES
 
The Company leases facilities and certain equipment under agreements accounted for as operating leases. These leases generally require the Company to pay all executory costs such as maintenance and insurance. Rental expense for operating leases for the three and nine months ended September 30, 2004 was approximately $128 and $362, respectively, and approximately $117 and $317 for the three and nine months ended September 30, 2003, respectively.
 

 
  12  

 

In October 2004, the Company modified the existing lease for its principal executive offices in New York City. The modification included the extension of the term of the current lease to October 2007 as well as the addition of new space.
 
(5) LEGAL PROCEEDINGS
 
On or about December 2, 2002, MCI WorldCom Communications, Inc. filed a complaint against the Company in the United States District Court for the Southern District of New York, containing claims for unpaid invoices related to a contract with MCI for voice and data services. The complaint sought to recover approximately $761 plus interest. The District Court dismissed the action on the Company’s motion on May 29, 2003 because the contract contained a binding arbitration provision. The matter is presently pending for arbitration with JAMS in New York City in which the Company has denied liability.
 
Although the Company believes that it has meritorious defenses and intends to defend vigorously the matter described above, and believes that the Company has provided adequate reserves in connection with this claim, the Company cannot assure you that the Company’s defenses will be successful and, if they are not, that the Company’s ultimate liability in connection with this claim will not exceed the Company’s reserves or have a material adverse effect on the Company’s results of operations, financial condition, or cash flows.
 
In June 2003, James Ball d/b/a TalktoDealers.com filed a complaint against the Company and other unidentified persons in the Superior Court of the State of California for the County of Orange, containing claims for breach of contract and unjust enrichment. The complaint sought to recover approximately $1,152 per year from the time of the Company’s alleged breach in late 2002 or early 2003, plus interest, costs, attorneys’ fees, restitution and specific performance. This matter was settled in November 2004 for $250, and the Company reserved that amount as of September 30, 2004 (see note 2).
 

  13  

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
 
GENERAL
 
Our discussion and analysis of our financial condition and results of operations are based upon our unaudited interim condensed consolidated financial statements, which are prepared in conformity with accounting principles generally accepted in the United States of America. As such, we are required to make certain estimates, judgments and assumptions that management believes are reasonable based upon the information available. We base these estimates on our historical experience, future expectations and various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for our judgments that may not be readily apparent from other sources. These estimates and assumptions affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the dates of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting periods. These estimates and assumptions relate to estimates of collectibility of accounts receivable, the realization of goodwill, the expected term of a client relationship, accruals and other factors. We evaluate these estimates on an ongoing basis. Actual results could differ from those estimates under different assumptions or conditions, and any differences could be material.
 
The significant accounting policies which we believe are the most critical to aid in fully understanding and evaluating the reported consolidated financial results include the following:
 
REVENUE RECOGNITION
 
LivePerson is a provider of communications solutions for online sales, marketing and customer service. LivePerson’s Timpani software platform enables online businesses to identify and engage website visitors with the appropriate communication channel, thereby enhancing the online experience. Chat, marketing and selling tools, a self-service knowledgebase and email management are combined with channel matching technology, rules-based intelligence, routing and reporting to enable clients to increase sales, lower customer service costs and enhance the customer experience. We charge a monthly fee, which varies by service. Certain of our larger clients, who require more sophisticated implementation and training, may also pay an initial non-refundable set-up fee and professional service fees related to training and implementation.
 
The initial set-up fee is intended to recover certain costs (principally customer service, training and other administrative costs) prior to the deployment of our services. Such fees are recorded as deferred revenue and recognized ratably over a period of 24 months, representing the estimated term of the client relationships. Although we believe this estimate is reasonable, this estimate may change in the future. In instances where we do charge a set-up fee, we typically do not charge an additional set-up fee if an existing client adds more services. Unamortized deferred fees, if any, are recognized upon termination of the agreement with the customer. We recognized $0 and $2,000 in the three and nine months ended September 30, 2004, respectively, and $0 and $0 in the three and nine months ended September 30, 2003, respectively, of set-up fees due to client attrition.
 
We also sell certain of the LivePerson Timpani services directly via Internet download. These services are marketed as Timpani SB for small- and medium-sized businesses, and are paid for almost exclusively by credit card. Credit card payments accelerate cash flow and reduce our collection risk, subject to the merchant bank’s right to hold back cash pending settlement of the transactions. Sales executed via Internet download may occur with or without the assistance of an online sales representative, rather than through face-to-face or telephone contact that is typically required for traditional direct sales. Sales of the LivePerson services via Internet download typically have no set-up fee, because we do not provide the customer with training and administrative costs are minimal.
 
We record revenue for traditional direct sales and Internet download sales based upon a monthly fee charged for the LivePerson services, provided that no significant Company obligations remain and collection of the resulting receivable is probable. We recognize monthly service revenue fees as services are provided. Our service agreements typically have no termination date and are terminable by either party upon 30 to 90 days’ notice without penalty. We recognize professional service fees upon completion and customer acceptance of the professional service engagement.
 

 
  14  

 

ACCOUNTS RECEIVABLE
 
Our customers are primarily concentrated in the United States. We perform ongoing credit evaluations of our customers’ financial condition (except for customers who purchase the LivePerson services via Internet download) and have established an allowance for doubtful accounts based upon factors surrounding the credit risk of customers, historical trends and other information that we believe to be reasonable, although they may change in the future. If there is a deterioration of a customer’s credit worthiness or actual write-offs are higher than our historical experience, our estimates of recoverability for these receivables could be adversely affected. Our concentration of credit risk is limited due to the large number of customers. No single customer accounted for or exceeded 10% of our total revenue in the three or nine months ended September 30, 2004 and 2003. One customer accounted for approximately 16% of accounts receivable at September 30, 2004. Two customers accounted for approximately 22% of accounts receivable at December 31, 2003.
 
IMPAIRMENT OF LONG-LIVED ASSETS
 
We adopted Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-lived Assets,” on January 1, 2002. SFAS No. 144 requires long-lived assets, such as property, plant and equipment and purchased intangibles subject to amortization to be reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying value of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying value of an asset exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying value of the asset exceeds the fair value of the asset. Assets to be disposed of would be separately presented in the balance sheet and reported at the lower of the carrying value or the fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a disposed group classified as held for sale would be presented separately in the appropriate asset and liability sections of the balance sheet. The adoption of SFAS No. 144 did not have any impact on our financial condition or results of operations.
 
RECENT ACCOUNTING PRONOUNCEMENTS
 
In March 2004, the Financial Accounting Standards Board (“FASB”) issued for exposure a Proposed Statement of Financial Accounting Standards entitled “Share-Based Payment - an Amendment of SFAS Nos. 123 and 95.” The proposal requires that the fair value of employee stock-based compensation be expensed. Although the proposal differs from SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure,” the proposal’s requirements will only apply to new grants of stock or options to employees. We will continue to monitor the progress of the FASB with regard to the final requirements of this new standard.
 
FASB Interpretation No. 46, “Consolidation of Variable Interest Entities - An Interpretation of APB No. 51,” as amended by FASB Interpretation No. 46R, is effective in 2004. FASB Interpretation No. 46 addresses the consolidation by business enterprises of variable interest entities, as defined in the interpretation, and is based on the concept that companies that control another entity through interests, other than voting interests, should consolidate the controlled entity. The FASB subsequently issued Interpretation No. 46R in December 2003, which modified certain provisions of FASB Interpretation No. 46, and which must be applied to the first reporting period after March 15, 2004. FASB Interpretation No. 46, as amended by FASB Interpretation No. 46R, did not have an impact on our financial position, cash flows or results of operations, or result in additional disclosure in our financial statements.
 
In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150 established standards for the classification and measurement of certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 also includes required disclosures for financial instruments within its scope. SFAS No. 150 was effective for our instruments entered into or modified after May 31, 2003 and otherwise will be effective as of January 1, 2004, except for mandatorily redeemable financial instruments. For these mandatorily redeemable financial instruments, SFAS No. 150 will be effective for us on January 1, 2005. The effective date has been deferred indefinitely for certain other types of mandatorily redeemable financial instruments. We do not have any financial instruments that are within the scope of SFAS No. 150; therefore the issuance of SFAS No. 150 did not have an impact on our financial position, cash flows or results of operations.
 

 
  15  

 

In December 2003, the staff of the Securities and Exchange Commission issued Staff Accounting Bulleting (“SAB”) No. 104, “Revenue Recognition,” which supersedes SAB No. 101, “Revenue Recognition in Financial Statements.” SAB No. 104 primarily rescinds the accounting guidance contained in SAB No. 101 related to multiple-element revenue arrangements, which was superseded as a result of the issuance of Emerging Issues Task Force Issue No. 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.” Additionally, SAB No. 104 rescinds the SEC’s “Revenue Recognition in Financial Statements Frequently Asked Questions and Answers” issued with SAB No. 101, which had been codified in SEC Topic 13, “Revenue Recognition.” SAB No. 104 was effective upon issuance. The issuance of SAB No. 104 did not have any impact on our financial position, cash flows or results of operations.
 
OVERVIEW
 
LivePerson, an online communication application service provider (ASP), delivers real-time sales, marketing and customer service solutions for companies that conduct business online. We offer our proprietary real-time interaction technology as outsourced services. We currently generate revenue from the sale of the LivePerson services under the brand name Timpani, which enable our clients to communicate directly with Internet users via text-based chat, integrated email functionality or a searchable knowledgebase. Our integrated communication software enables a consolidated view of incoming inquiries, via chat, email and self-service channels.
 
We were incorporated in the State of Delaware in November 1995 and the initial LivePerson service was introduced in November 1998.
 
In July 2002, we acquired all of the existing customer contracts of NewChannel, Inc. and associated rights. The purchase price was based, in part, on projected revenue from each of the former NewChannel clients at the time of their successful conversion to the LivePerson software platform. Our acquisition cost was approximately $1.4 million, including the initial purchase price payment of $600,000 to NewChannel. The total acquisition cost has been allocated to customer contracts and was amortized ratably over a period of 18 months, representing the then expected term of the client relationships. As of December 31, 2003, the total purchase had been completely amortized.
 
In December 2003, we acquired certain identifiable assets of Island Data Corporation. The purchase price was based on projected revenue from the acquired customer contracts at the time of their assignment to us. As of September 30, 2004, we paid approximately $370,000 in cash, and issued 370,894 shares of our common stock, in connection with the acquisition. The total acquisition costs were approximately $2.1 million. Of the total purchase price, we have allocated approximately $65,000 to non-compete agreements which will be amortized over a period of 24 months, representing the terms of the agreements. The remainder of the purchase has been allocated to customer contracts and will be amortized over a period of 36 months, representing our current estimate of the term of the acquired client relationships. The net acquisition costs of $1.6 million are included in “Assets - Other intangibles, net” on our September 30, 2004 balance sheet.
 
In January 2004, we filed a registration statement with the Securities and Exchange Commission to register the resale of up to 500,000 shares of our common stock by Island Data. Our registration of the resale of the shares was required by our agreement with Island Data. The shares registered for resale on the registration statement, but not actually issued to Island Data pursuant to the agreement, will be deregistered. We will not receive any proceeds from the sale of the shares of common stock covered by the Island Data registration statement.
 
In January 2004, we filed a shelf registration statement with the Securities and Exchange Commission relating to 4,000,000 shares of our common stock that we may issue from time to time. We have no immediate plans to offer or sell any shares under this shelf registration. We presently intend to use the net proceeds from any sale of the registered shares for general corporate purposes, working capital and potential strategic acquisitions. We would announce the terms of any issuance in a filing with the Securities and Exchange Commission at the time we offer or sell the shares.
 

 
  16  

 

In July 2004, we acquired certain identifiable assets of FaceTime Communications, Inc. The transaction transferred certain existing customer contracts of FaceTime to us. The purchase price was based in part on future revenue generated by us from the former FaceTime client base. As of September 30, 2004, we incurred total transaction costs of approximately $394,000, including the initial purchase price payment of $200,000 to FaceTime. We expect the total cost of the transaction to be less than $400,000. The total acquisition cost will be amortized ratably over a period of 24 months, representing our current estimate of the term of the acquired client relationships. The net acquisition costs of $369,000 are included in “Assets - Other intangibles, net” on our September 30, 2004 balance sheet.
 
REVENUE
 
Our clients pay us a monthly fee, which varies by service. LivePerson’s Timpani product line includes: Timpani Contact Center for customer service; Timpani Sales & Marketing for proactive online engagement; and Timpani SB for small business customer support.
 
Certain of our larger clients, who require more sophisticated implementation and training, may also pay an initial non-refundable set-up fee. Our set-up fee is intended to recover certain costs incurred by us (principally customer service, training and other administrative costs) prior to deployment of our services. Such fees are recorded as deferred revenue and recognized over a period of 24 months, representing the estimated term of the client relationships. As a result of recognizing set-up fees in this manner, combined with the fact that a small proportion of our clients are charged a set-up fee, revenue attributable to our monthly service fee accounted for 97% and 96% of total LivePerson services revenue for the three and nine months ended September 30, 2004, respectively, and 98% and 98% of total LivePerson services revenue for the three and nine months ended September 30, 2003, respectively. In addition, because we typically do not charge a set-up fee for sales generated via Internet download, we expect the set-up fee to continue to represent a small percentage of total revenue. In instances where we do charge a set-up fee, we typically do not charge an additional set-up fee if an existing client adds more services. Our service agreements typically have no termination date and are terminable by either party upon 30 to 90 days’ notice without penalty. We recognize monthly service revenue fees and professional service fees as services are provided. Professional service fees consist of additional training and business consulting and analysis provided to customers, both at the initial launch and over the term of the contract. Given the time required to schedule training for our clients’ operators and our clients’ resource constraints, we have historically experienced a lag between signing a client contract and generating revenue from that client. This lag has generally ranged from one day to 30 days. There is no lag for sales generated via Internet download, because our services are immediately available and fully functional upon download. To date, revenue from professional services has not been material.
 
We also sell certain of the LivePerson services directly via Internet download. These services are marketed as Timpani SB for small- and medium-sized businesses, and are paid for almost exclusively by credit card. Credit card payments accelerate cash flow and reduce our collection risk, subject to the merchant bank’s right to hold back cash pending settlement of the transactions. Sales executed via Internet download may occur with or without the assistance of an online sales representative, rather than through face-to-face or telephone contact which is typically required for traditional direct sales. Sales of the LivePerson services via Internet download typically have no set-up fee, because we do not provide the customer with training, and administrative costs are minimal. We recognize monthly service revenue fees from Internet downloads as services are provided.
 
We also have entered into contractual arrangements that complement our direct sales force and online sales efforts. These are primarily with Web hosting and call center service companies, pursuant to which LivePerson is paid a commission based on revenue generated by these service companies from our referrals. To date, revenue from such commissions has not been material.
 

 
  17  

 

OPERATING EXPENSES
 
Our cost of revenue has principally been associated with the LivePerson services and has consisted of:
 
·   compensation costs relating to employees who provide customer service to our clients;
 
·   compensation costs relating to our network support staff;
 
·   allocated occupancy costs and related overhead; and
 
·   the cost of supporting our infrastructure, including expenses related to server leases and Internet connectivity, as well as depreciation of certain hardware and software.
 
Our product development expenses consist primarily of compensation and related expenses for product development personnel, allocated occupancy costs and related overhead, outsourced labor and expenses for testing new versions of our software. Product development expenses are charged to operations as incurred.
 
Our sales and marketing expenses consist of compensation and related expenses for sales personnel and marketing personnel, allocated occupancy costs and related overhead, advertising, sales commissions, marketing programs, public relations, promotional materials, travel expenses and trade show exhibit expenses.
 
Our general and administrative expenses consist primarily of compensation and related expenses for executive, accounting and human resources personnel, allocated occupancy costs and related overhead, professional fees, provision for doubtful accounts and other general corporate expenses.
 
In the nine months ended September 30, 2004, we increased our allowance for doubtful accounts by $15,000 to approximately $79,000, principally due to an increase in accounts receivable as a result of increased sales. We base our allowance for doubtful accounts on specifically identified credit risks of customers, historical trends and other information that we believe to be reasonable. We adjust our allowance for doubtful accounts when accounts previously reserved have been collected.
 
RESULTS OF OPERATIONS
 
Due to our acquisition of the FaceTime customer contracts in July 2004, our acquisition of the Island Data customer contracts in December 2003, our acquisition of the NewChannel customer contracts and associated rights in July 2002 and our limited operating history, we believe that comparisons of our operating results for the three and nine months ended September 30, 2004 and 2003 with each other, or with those of prior periods, are not meaningful and that our historical operating results should not be relied upon as indicative of future performance.
 
COMPARISON OF THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
 
Revenue. Total revenue increased to $4.4 million and $12.8 million in the three and nine months ended September 30, 2004 from $3.1 million and $8.5 million in the comparable periods in 2003. This increase is primarily attributable to increased revenue from existing clients, the addition of new clients and, to a lesser extent, to the acquisition of the Island Data customer contracts and associated rights in December 2003 and the acquisition of the FaceTime customer contracts in July 2004. Revenue in the three and nine months ended September 30, 2004 included the recognition of $0 and $2,000, respectively, of set-up fees due to client attrition. Revenue in the three and nine months ended September 30, 2003 included the recognition of $0 and $0, respectively, of set-up fees due to client attrition. Unamortized deferred fees, if any, are recognized upon termination of the agreement with the client. We cannot assure you that we will achieve similar revenue growth, if any, in future periods.
 
Cost of Revenue. Cost of revenue consists of compensation costs relating to employees who provide customer service to our clients, compensation costs relating to our network support staff, the cost of supporting our infrastructure, including expenses related to server leases and Internet connectivity, as well as depreciation of certain hardware and software, and allocated occupancy costs and related overhead. Cost of revenue increased to $730,000 and $2.1 million in the three and nine months ended September 30, 2004 from $501,000 and $1.5 million in the comparable periods in 2003. This increase is attributable to an increase in the number of account management personnel to support both increased client activity as well as activity driven by the acquisition of the Island Data customer contracts and associated rights in December 2003, increased spending for backup server facilities, increased usage from existing clients, the addition of new clients and, to a lesser extent, to the acquisition of the FaceTime customer contracts in July 2004.
 

 
  18  

 

Product Development. Our product development expenses consist primarily of compensation and related expenses for product development personnel. Product development costs increased to $515,000 and $1.5 million for the three and nine months ended September 30, 2004 from $419,000 and $1.2 million in the comparable periods in 2003. This increase is attributable to an increase in the number of LivePerson product development personnel to support both the launch of a significant new release of the LivePerson services under the Timpani brand name and, to a lesser extent, an increase in outsourced labor costs related to the continuing development of our product line as we broaden the range of services we offer to include a fully integrated, multi-channel software platform.
 
Sales and Marketing. Our sales and marketing expenses consist of compensation and related expenses for sales and marketing personnel, as well as advertising and trade show exhibit expenses. Sales and marketing expenses increased to $1.3 million and $3.7 million in the three and nine months ended September 30, 2004 from $910,000 and $2.5 million in the comparable periods in 2003. This increase is primarily attributable to an increase in sales and marketing personnel as a result of the expansion of our sales force, and, to a lesser extent, to an increase in on-line advertising and marketing expenses related to our increasing efforts to enhance our brand recognition and to increased sales lead activity.
 
General and Administrative. Our general and administrative expenses consist primarily of compensation and related expenses for executive, accounting, human resources and administrative personnel. General and administrative expenses increased to $1.2 million in the three months ended September 30, 2004 from $1.0 million in the comparable period in 2003. This increase is primarily related to the settlement of a previously disclosed legal matter and increases in professional services and recruitment costs, partially offset by a decrease in non-cash compensation expense. General and administrative expenses increased to $3.1 million in the nine months ended September 30, 2004 from $2.7 million in the comparable period in 2003. This increase is primarily attributable to the settlement of a previously disclosed legal matter and increases in professional services and recruitment costs related to the expansion of our sales force.
 
Amortization of Intangibles. Amortization expense was $204,000 and $563,000 in the three and nine months ended September 30, 2004 and relates to acquisition costs recorded as a result of our acquisitions of certain identifiable assets of Island Data and FaceTime. Amortization expense was $253,000 and $760,000 in the three and nine months ended September 30, 2003 and relates to acquisition costs recorded as a result of our acquisition of the NewChannel customer contracts and associated rights in July 2002.
 
Restructuring Charge. In the three months ended June 30, 2003, we recorded an additional restructuring charge of approximately $1.0 million related to our 2001 restructuring initiatives. This charge reflected the amount of the judgment in a previously disclosed arbitration proceeding in excess of the $350,000 provision initially provided for in connection with our original restructuring plan in 2001. Because our June 30, 2003 interim financial statements were not yet filed with the SEC when we received notification of the judgment, the recording of this charge in the three months ended June 30, 2003 was required pursuant to SFAS No. 5, “Accounting for Contingencies” and Statement of Auditing Standards No. 1, “Codification of Auditing Standards and Procedures, section 560 — Subsequent Events.”
 
Other Income. Interest income was $18,000 and $41,000 for the three and nine months ended September 30, 2004 and $9,000 and $28,000 in the comparable periods in 2003, respectively, and consists of interest earned on cash and cash equivalents generated by the receipt of proceeds from our initial public offering in 2000 and preferred stock issuances in 2000 and 1999, and to a lesser extent, to cash provided by operating activities. Other expense was $0 and $8,000 for the three and nine months ended September 30, 2003 and was related to the write-off of our accumulated other comprehensive loss in connection with the closing of our operations in the United Kingdom.
 
Net Income (Loss). We had net income of $376,000 and $1.8 million in the three and nine months ended September 30, 2004 compared to net income of $9,000 and a net loss of $1.1 for the comparable periods in 2003.
 

 
  19  

 

LIQUIDITY AND CAPITAL RESOURCES
 
As of September 30, 2004, we had approximately $12.3 million in cash and cash equivalents, an increase of $1.4 million from December 31, 2003. This increase is attributable to net cash provided by operating activities during the nine months ended September 30, 2004, offset in part by net cash used in investing activities. We regularly invest excess funds in short-term money market funds.
 
Net cash provided by operating activities was $1.8 million for the nine months ended September 30, 2004 and consisted of net income and non-cash expenses related to the amortization of other intangibles, non-cash compensation and depreciation offset by decreases in accrued expenses, deferred revenue and an increase in prepaid expenses. Net cash provided by operating activities was $923,000 for the nine months ended September 30, 2003 and consisted primarily of a net loss offset by increases in accrued expenses, deferred revenue and amortization of intangibles, partially offset by an increase in prepaid expenses.
 
Net cash used in investing activities was $499,000 for the nine months ended September 30, 2004 and was due to the purchase of fixed assets and the acquisition of the FaceTime customer contracts in July 2004. Net cash used in investing activities was $32,000 in the nine months ended September 30, 2003 and was due to the purchase of fixed assets.
 
Net cash provided by financing activities was $96,000 and $741,000 for the nine months ended September 30, 2004 and 2003, respectively, and consisted of proceeds from the issuance of common stock in connection with the exercise of options.
 
We have incurred significant costs to develop our technology and services, to hire employees in our customer service, sales, marketing and administration departments, and for the amortization of goodwill and other intangible assets, as well as non-cash compensation costs. Historically, we incurred significant quarterly net losses from inception through June 30, 2003, significant negative cash flows from operations in our quarterly periods from inception through December 31, 2002 and negative cash flows from operations of $124,000 in the three month period ended March 31, 2004. As of September 30, 2004, we had an accumulated deficit of approximately $104.2 million. These losses have been funded primarily through the issuance of common stock in our initial public offering and, prior to the initial public offering, the issuance of convertible preferred stock.
 
We anticipate that our current cash and cash equivalents will be sufficient to satisfy our working capital and capital requirements for at least the next 12 months. However, we cannot assure you that we will not require additional funds prior to such time, and we would then seek to sell additional equity or debt securities through public financings, or seek alternative sources of financing. We cannot assure you that additional funding will be available on favorable terms, when needed, if at all. If we are unable to obtain any necessary additional financing, we may be required to further reduce the scope of our planned sales and marketing and product development efforts, which could materially adversely affect our business, financial condition and operating results. In addition, we may require additional funds in order to fund more rapid expansion, to develop new or enhanced services or products or to invest in complementary businesses, technologies, services or products.
 
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
 
We do not have any special purposes entities, and other than operating leases, which are described below, we do not engage in off-balance sheet financing arrangements.
 
We lease facilities and certain equipment under agreements accounted for as operating leases. These leases generally require us to pay all executory costs such as maintenance and insurance. Rental expense for operating leases for the three and nine months ended September 30, 2004 was approximately $128,000 and $362,000, respectively, and approximately $117,000 and $317,000 for the three and nine months ended September 30, 2003, respectively.
 
As of September 30, 2004, our principal commitments were approximately $1.5 million under various operating leases, of which approximately $140,000 is due in 2004. We do not currently expect that our principal commitments for the year ending December 31, 2004 will exceed $2.0 million in the aggregate. Our capital expenditures are not currently expected to exceed $400,000 in 2004. Our contractual obligations at September 30, 2004 are summarized as follows:
 

 
  20  

 

   
Payments due by period
 
   
(in thousands)
 
Contractual Obligations
 
Total
 
Less than
1 year
 
1-3 years
 
3-5 years
 
More than
5 years
 
Operating leases
 
$
1,549
 
$
140
 
$
596
 
$
478
 
$
335
 
Total
 
$
1,549
 
$
140
 
$
596
 
$
478
 
$
335
 

 
In October 2004, we modified the existing lease for our principal executive offices in New York City. The modification included the extension of the term of our current lease to October 2007 as well as the addition of new space.
 
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
 
Risks Related to Our Business
 
We have a history of losses, we had an accumulated deficit of $104.2 million as of September 30, 2004 and we may incur losses in the future.
 
Although we have achieved profitability in each three-month period since and including the period ended September 30, 2003, we may, in the future, incur losses and experience negative cash flow, either or both of which may be significant. We recorded a net loss of $27.3 million for the year ended December 31, 2001, $6.8 million for the year ended December 31, 2002 and $816,000 for the year ended December 31, 2003. We recorded net income of $1.8 million in the nine months ended September 30, 2004. As of September 30, 2004, our accumulated deficit was approximately $104.2 million. We cannot assure you that we can sustain or increase profitability on a quarterly or annual basis in the future. Failure to maintain profitability may materially and adversely affect the market price of our common stock.
 
Our quarterly revenue and operating results are subject to significant fluctuations, which may adversely affect the trading price of our common stock.
 
Our quarterly revenue and operating results may fluctuate significantly in the future due to a variety of factors, including the following factors which are in part within our control, and in part outside of our control:
 
·   market acceptance by companies doing business online of real-time sales, marketing and customer service solutions;
 
·   our clients’ business success;
 
·   our clients’ demand for our services;
 
·   our ability to attract and retain clients;
 
·   the amount and timing of capital expenditures and other costs relating to the expansion of our operations, including those related to acquisitions;
 
·   the introduction of new services by us or our competitors; and
 
·   changes in our pricing policies or the pricing policies of our competitors.
 

 
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Our revenue and results may also fluctuate significantly in the future due to the following factors that are entirely outside of our control:
 
·   economic conditions specific to the Internet, electronic commerce and online media; and
 
·   general economic and political conditions.
 
Period-to-period comparisons of our operating results may not be meaningful because of these factors. You should not rely upon these comparisons as indicators of our future performance.
 
Due to the foregoing factors, it is possible that our results of operations in one or more future quarters may fall below the expectations of securities analysts and investors. If this occurs, the trading price of our common stock could decline.
 
We may be unable to respond to the rapid technological change and changing client preferences in the online sales, marketing and customer service industry and this may harm our business.
 
If we are unable, for technological, legal, financial or other reasons, to adapt in a timely manner to changing market conditions in the online sales, marketing and customer service industry or our clients’ or Internet users’ requirements, our business, results of operations and financial condition would be materially and adversely affected. Business on the Internet is characterized by rapid technological change. In addition, the market for online sales, marketing and customer service solutions is relatively new. Sudden changes in client and Internet user requirements and preferences, frequent new product and service introductions embodying new technologies, such as broadband communications, and the emergence of new industry standards and practices could render the LivePerson services and our proprietary technology and systems obsolete. The rapid evolution of these products and services will require that we continually improve the performance, features and reliability of our services. Our success will depend, in part, on our ability to:
 
·   enhance the features and performance of the LivePerson services;
 
·   develop and offer new services that are valuable to companies doing business online and Internet users; and
 
·   respond to technological advances and emerging industry standards and practices in a cost-effective and timely manner.
 
If any of our new services, including upgrades to our current services, do not meet our clients’ or Internet users’ expectations, our business may be harmed. Updating our technology may require significant additional capital expenditures and could materially and adversely affect our business, results of operations and financial condition.
 
If new services require us to grow rapidly, this could place a significant strain on our managerial, operational, technical and financial resources. In order to manage our growth, we could be required to implement new or upgraded operating and financial systems, procedures and controls. Our failure to expand our operations in an efficient manner could cause our expenses to grow, our revenue to decline or grow more slowly than expected and could otherwise have a material adverse effect on our business, results of operations and financial condition.
 
If we are not competitive in the market for real-time sales, marketing and customer service solutions, our business could be harmed.
 
The market for real-time sales, marketing and customer service solutions is intensely competitive. Relatively few substantial barriers to entry exist in this market, other than the ability to design and build scalable software and, with respect to outsourced solution providers, the ability to design, build and manage scalable network architecture. Established or new entities may enter this market in the near future, including those that provide real-time interaction online, with or without the user’s request.
 
We compete directly with companies focused on technology that facilitates real-time sales, email management, searchable knowledgebase applications and customer service interaction. These markets remain fairly saturated with small companies that compete on price and features. We also face significant competition from two customer service enterprise software providers, KANA and RightNow Technologies, which offer hosted solutions. Furthermore, many of our competitors offer a broader range of customer relationship management products and services than we currently offer. We may be disadvantaged and our business may be harmed if companies doing business online choose real-time sales, marketing and customer service solutions from such providers.
 

 
  22  

 

We also face potential competition from larger enterprise software companies such as Oracle and Siebel Systems. In addition, established technology companies, including Aspect Communications, Avaya, Genesys Telecommunications Laboratories, IBM and Microsoft, may also leverage their existing relationships and capabilities to offer real-time sales, marketing and customer service applications.
 
Finally, we face competition from clients and potential clients that choose to provide a real-time sales, marketing and customer service solution in-house as well as, to a lesser extent, traditional offline customer service solutions, such as telephone call centers.
 
We believe that competition will increase as our current competitors increase the sophistication of their offerings and as new participants enter the market. Many of our larger current and potential competitors have:
 
·   longer operating histories;
 
·   greater brand recognition;
 
·   more diversified lines of products and services; and
 
·   significantly greater financial, marketing and other resources.
 
Some competitors may enter into strategic or commercial relationships with larger, more established and better-financed companies. These competitors may be able to:
 
·   undertake more extensive marketing campaigns;
 
·   adopt more aggressive pricing policies; and
 
·   make more attractive offers to businesses to induce them to use their products or services.
 
Any delay in the general market acceptance of the real-time sales, marketing and customer service solution business model would likely harm our competitive position. Delays would allow our competitors additional time to improve their service or product offerings, and would also provide time for new competitors to develop real-time sales, marketing and customer service applications and solicit prospective clients within our target markets. Increased competition could result in pricing pressures, reduced operating margins and loss of market share.
 
The success of our business is dependent on the retention of existing clients and their purchase of additional LivePerson services.
 
Our LivePerson services agreements typically have no termination date and are terminable upon 30 to 90 days’ notice without penalty. If a significant number of our clients, or any one client to whom we provide a significant amount of services, were to terminate these services agreements, or reduce the amount of services purchased or fail to purchase additional services, our results of operations may be negatively and materially affected. Dissatisfaction with the nature or quality of our services could also lead clients to terminate our service. We depend on monthly fees from the LivePerson services for substantially all of our revenue. If our retention rate declines, our revenue could decline unless we are able to obtain additional clients or alternate revenue sources. Further, because of the historically small amount of services sold in initial orders, we depend on sales to new clients and sales of additional services to our existing clients. In addition, we cannot assure you that we will be able to retain as clients those customers of the Express Response hosted knowledgebase and FAQ service we acquired from Island Data Corporation in December 2003 or those customers of FaceTime Communications, Inc. we acquired in July 2004.
 

 
  23  

 

We are dependent on technology systems that are beyond our control.
 
The success of the LivePerson services depends in part on our clients’ online services as well as the Internet connections of visitors to their Web sites, both of which are outside of our control. As a result, it may be difficult to identify the source of problems if they occur. In the past, we have experienced problems related to connectivity which have resulted in slower than normal response times to Internet user chat requests and messages and interruptions in service. The LivePerson services rely both on the Internet and on our connectivity vendors for data transmission. Therefore, even when connectivity problems are not caused by the LivePerson services, our clients or Internet users may attribute the problem to us. This could diminish our brand and harm our business, divert the attention of our technical personnel from our product development efforts or cause significant client relations problems.
 
In addition, we rely on a third-party Web hosting service provider for Internet connectivity and network infrastructure hosting, security and maintenance. The provider has, in the past, experienced problems that have resulted in slower than normal response times and interruptions in service. If we are unable to continue utilizing the services of our existing Web hosting provider or if our Web hosting services experience interruptions or delays, it is possible that our business could be harmed.
 
Our service also depends on many third parties for hardware and software, which products could contain defects. Problems arising from our use of such hardware or software could require us to incur significant costs or divert the attention of our technical personnel from our product development efforts. To the extent any such problems require us to replace such hardware or software, we may not be able to do so on acceptable terms, if at all.
 
Technological defects could disrupt our services, which could harm our business and reputation.
 
We face risks related to the technological capabilities of the LivePerson services. We expect the number of interactions between our clients’ operators and Internet users over our system to increase significantly as we expand our client base. Our network hardware and software may not be able to accommodate this additional volume. Additionally, we must continually upgrade our software to improve the features and functionality of the LivePerson services in order to be competitive in our market. If future versions of our software contain undetected errors, our business could be harmed. As a result of major software upgrades at LivePerson, our client sites have, from time to time, experienced slower than normal response times and interruptions in service. If we experience system failures or degraded response times, our reputation and brand could be harmed. We may also experience technical problems in the process of installing and initiating the LivePerson services on new Web hosting services. These problems, if unremedied, could harm our business.
 
The LivePerson services also depend on complex software which may contain defects, particularly when we introduce new versions onto our servers. We may not discover software defects that affect our new or current services or enhancements until after they are deployed. It is possible that, despite testing by us, defects may occur in the software. These defects could result in:
 
·   damage to our reputation;
 
·   lost sales;
 
·   delays in or loss of market acceptance of our products; and
 
·   unexpected expenses and diversion of resources to remedy errors.
 
Our clients may experience adverse business conditions that could adversely affect our business.
 
Some of our clients may experience difficulty in supporting their current operations and implementing their business plans. These clients may reduce their spending on our services, or may not be able to discharge their payment and other obligations to us. These circumstances are influenced by general economic and industry-specific conditions, and could have a material adverse impact on our business, financial condition and results of operations. In addition, as a result of these conditions, our clients, in particular our Internet-related clients that may experience (or that anticipate experiencing) difficulty raising capital, may elect to scale back the resources they devote to customer service technology, including services such as ours. If the current environment for our clients, including, in particular, our Internet-related clients, does not improve, our business, results of operations and financial condition could be materially adversely affected. In addition, the non-payment or late payment of amounts due to us from a significant number of clients would negatively impact our financial condition. We increased our allowance for doubtful accounts by $15,000 to approximately $79,000 in the nine months ended September 30, 2004, principally due to an increase in accounts receivable as a result of increased sales. During the year ended December 31, 2003, we increased our allowance for doubtful accounts by $15,000, principally due to an increase in accounts receivable as a result of increased sales, and we wrote off approximately $21,000 of previously reserved accounts, leaving a net allowance of $64,000 at December 31, 2003.
 

 
  24  

 

Our business is significantly dependent on our ability to retain our current key personnel, to attract new personnel, and to manage staff attrition.
 
Our future success depends to a significant extent on the continued services of our senior management team, including Robert P. LoCascio, our founder and Chief Executive Officer. The loss of the services of any member of our senior management team, in particular Mr. LoCascio, could have a material and adverse effect on our business, results of operations and financial condition. We cannot assure you that we would be able to successfully integrate newly-hired senior managers who would work together successfully with our existing management team.
 
We may be unable to attract, integrate or retain other highly qualified employees in the future. If our retention efforts are ineffective, employee turnover could increase and our ability to provide services to our clients would be materially and adversely affected.
 
Any staff attrition we experience, whether initiated by the departing employees or by us, could place a significant strain on our managerial, operational, financial and other resources. To the extent that we do not initiate or seek any staff attrition that occurs, there can be no assurance that we will be able to identify and hire adequate replacement staff promptly, if at all, and even that if such staff is replaced, we will be successful in integrating these employees. In addition, we may not be able to outsource certain functions. We expect to evaluate our needs and the performance of our staff on a periodic basis, and may choose to make adjustments in the future. If the size of our staff is significantly reduced, either by our choice or otherwise, it may become more difficult for us to manage existing, or establish new, relationships with clients and other counter-parties, or to expand and improve our service offerings. It may also become more difficult for us to implement changes to our business plan or to respond promptly to opportunities in the marketplace. Further, it may become more difficult for us to devote personnel resources necessary to maintain or improve existing systems, including our financial and managerial controls, billing systems, reporting systems and procedures. Thus, any significant amount of staff attrition could cause our business and financial results to suffer.
 
We cannot predict our future capital needs to execute our business strategy and we may not be able to secure additional financing.
 
We believe that our current cash and cash equivalents and cash generated from operations, if any, will be sufficient to fund our working capital and capital expenditure requirements for at least the next twelve months. To the extent that we require additional funds to support our operations or the expansion of our business, or to pay for acquisitions, we may need to sell additional equity, issue debt or convertible securities or obtain credit facilities through financial institutions. In the past, we have obtained financing principally through the sale of preferred stock, common stock and warrants. If additional funds are raised through the issuance of debt or preferred equity securities, these securities could have rights, preferences and privileges senior to holders of common stock, and could have terms that impose restrictions on our operations. If additional funds are raised through the issuance of additional equity or convertible securities, our stockholders could suffer dilution. We cannot assure you that additional funding, if required, will be available to us in amounts or on terms acceptable to us. If sufficient funds are not available or are not available on acceptable terms, our ability to fund any potential expansion, take advantage of acquisition opportunities, develop or enhance our services or products, or otherwise respond to competitive pressures would be significantly limited. Those limitations would materially and adversely affect our business, results of operations and financial condition.
 

 
  25  

 

If we do not successfully integrate potential future acquisitions, our business could be harmed.
 
In the future, we may acquire or invest in complementary companies, products or technologies. Acquisitions and investments involve numerous risks to us, including:
 
·   difficulties in integrating operations, technologies, products and personnel with LivePerson;
 
·   diversion of financial and management resources from efforts related to the LivePerson services or other then-existing operations; risks of entering new markets beyond providing real-time sales, marketing and customer service solutions for companies doing business online;
 
·   potential loss of either our existing key employees or key employees of any companies we acquire; and
 
·   our inability to generate sufficient revenue to offset acquisition or investment costs.
 
These difficulties could disrupt our ongoing business, distract our management and employees, increase our expenses and adversely affect our results of operations. Furthermore, we may incur debt or issue equity securities to pay for any future acquisitions. The issuance of equity securities could be dilutive to our existing stockholders.
 
We could face additional regulatory requirements, tax liabilities and other risks as we expand internationally.
 
In October 2000, we acquired HumanClick, an Israeli-based provider of real-time online customer service applications. In addition, we are testing an outsourced sales and marketing service provider to sell the LivePerson services in Western Europe. There are risks related to doing business in international markets, such as changes in regulatory requirements, tariffs and other trade barriers, fluctuations in currency exchange rates, more stringent rules relating to the privacy of Internet users and adverse tax consequences. In addition, there are likely to be different consumer preferences and requirements in specific international markets. Furthermore, we may face difficulties in staffing and managing any foreign operations. One or more of these factors could harm any future international operations.
 
Our reputation depends, in part, on factors which are entirely outside of our control.
 
Our services typically appear as a LivePerson-branded or a custom-created icon on our clients’ Web sites. The customer service operators who respond to the inquiries of our clients’ Internet users are employees or agents of our clients; they are not our employees. As a result, we have no way of controlling the actions of these operators. In addition, an Internet user may not know that the operator is an employee or agent of our client, rather than a LivePerson employee. If an Internet user were to have a negative experience in a LivePerson-powered or HumanClick-powered real-time dialogue, it is possible that this experience could be attributed to us, which could diminish our brand and harm our business. Finally, we believe the success of our services depend on the prominent placement of the icon on the client’s Web site, over which we also have no control.
 
Our business and prospects would suffer if we are unable to protect and enforce our intellectual property rights.
 
Our success and ability to compete depend, in part, upon the protection of our intellectual property rights relating to the technology underlying the LivePerson services. It is possible that:
 
·   any issued patent or patents issued in the future may not be broad enough to protect our intellectual property rights;
 
·   any issued patent or any patents issued in the future could be successfully challenged by one or more third parties, which could result in our loss of the right to prevent others from exploiting the inventions claimed in the patents;
 

 
  26  

 

·   current and future competitors may independently develop similar technologies, duplicate our services or design around any patents we may have; and
 
·   effective patent protection may not be available in every country in which we do business, where our services are sold or used, where the laws may not protect proprietary rights as fully as do the laws of the U.S. or where enforcement of laws protecting proprietary rights in not common or effective.
 
Further, to the extent that the invention described in any U.S. patent was made public prior to the filing of the patent application, we may not be able to obtain patent protection in certain foreign countries. We also rely upon copyright, trade secret, trademark and other common law in the U.S. and other jurisdictions, as well as confidentiality procedures and contractual provisions, to protect our proprietary technology, processes and other intellectual property, to the extent that protection is sought or secured at all. Any steps we might take may not be adequate to protect against infringement and misappropriation of our intellectual property by third parties. Similarly, third parties may be able to independently develop similar or superior technology, processes or other intellectual property. Policing unauthorized use of our services and intellectual property rights is difficult, and we cannot be certain that the steps we have taken will prevent misappropriation of our technology or intellectual property rights, particularly in foreign countries where we do business, where our services are sold or used, where the laws may not protect proprietary rights as fully as do the laws of the United States or where enforcement of laws protecting proprietary rights is not common or effective. The unauthorized reproduction or other misappropriation of our intellectual property rights could enable third parties to benefit from our technology without paying us for it. If this occurs, our business, results of operations and financial condition could be materially and adversely affected. In addition, disputes concerning the ownership or rights to use intellectual property could be costly and time-consuming to litigate, may distract management from operating our business and may result in our loss of significant rights.
 
Our products and services may infringe upon intellectual property rights of third parties and any infringement could require us to incur substantial costs and may distract our management.
 
We are subject to the risk of claims alleging infringement of third-party proprietary rights. Substantial litigation regarding intellectual property rights exists in the software industry. In the ordinary course of our business, our services may be increasingly subject to third-party infringement claims as the number of competitors in our industry segment grows and the functionality of services in different industry segments overlaps. Some of our competitors in the market for real-time sales, marketing and customer service solutions may have filed or may intend to file patent applications covering aspects of their technology. Any claims alleging infringement of third-party intellectual property rights could require us to spend significant amounts in litigation (even if the claim is invalid), distract management from other tasks of operating our business, pay substantial damage awards, prevent us from selling our products, delay delivery of the LivePerson services, develop non-infringing software, technology, business processes, systems or other intellectual property (none of which might be successful), or limit our ability to use the intellectual property that is the subject of any of these claims, unless we enter into license agreements with the third parties (which may be unavailable on commercially reasonable terms, or not available at all). Therefore, such claims could have a material adverse effect on our business, results of operations and financial condition.
 
We may be liable if third parties misappropriate personal information belonging to our clients’ Internet users.
 
We maintain dialogue transcripts of the text-based chats and email interactions between our clients and Internet users and store on our servers information supplied voluntarily by these Internet users in surveys. We provide this information to our clients to allow them to perform Internet user analyses and monitor the effectiveness of our services. Some of the information we collect may include personal information, such as contact and demographic information. If third parties were able to penetrate our network security or otherwise misappropriate personal information relating to our clients’ Internet users or the text of customer service inquiries, we could be subject to liability. We could be subject to negligence claims or claims for misuse of personal information. These claims could result in litigation, which could have a material adverse effect on our business, results of operations and financial condition. We may incur significant costs to protect against the threat of security breaches or to alleviate problems caused by such breaches.
 

 
  27  

 

The need to physically secure and securely transmit confidential information online has been a significant barrier to electronic commerce and online communications. Any well-publicized compromise of security could deter people from using online services such as the ones we offer, or from using them to conduct transactions, which involve transmitting confidential information. Because our success depends on the general acceptance of our services and electronic commerce, we may incur significant costs to protect against the threat of security breaches or to alleviate problems caused by these breaches.
 
Political, economic and military conditions in Israel could negatively impact our Israeli operations.
 
Our product development staff, help desk and online sales personnel are located in Israel. As of September 30, 2004, we had 27 full-time employees in Israel and as of December 31, 2003, we had 24 full-time employees in Israel. Although substantially all of our sales to date have been made to customers outside Israel, we are directly influenced by the political, economic and military conditions affecting Israel. Since the establishment of the State of Israel in 1948, a number of armed conflicts have taken place between Israel and its Arab neighbors. A state of hostility, varying in degree and intensity, has caused security and economic problems in Israel. Further, since September 2000, there has been a significant deterioration in the relationship between Israel and the Palestinian Authority and serious violence has ensued, the peace process between the parties has stagnated, and Israel’s relationship with several Arab countries has been adversely affected. Moreover, hostilities since 2002 have escalated significantly, with increased attacks in Israel and an armed conflict between Israel and the Palestinians in the West Bank and Gaza. Efforts to resolve the conflict have failed to result in an agreeable solution. Continued hostilities between the Palestinian community and Israel and any failure to settle the conflict could adversely affect our operations in Israel and our business. Further deterioration of the situation into a full-scale armed conflict might require more widespread military reserve service by some of our Israeli employees and might result in a significant downturn in the economic or financial condition of Israel, either of which could have a material adverse effect on our operations in Israel and our business. In addition, several Arab countries still restrict business with Israeli companies. Our operations in Israel could be adversely affected by restrictive laws or policies directed towards Israel and Israeli businesses.
 
Risks Related to Our Industry
 
We are dependent on the continued use of the Internet as a medium for commerce.
 
We cannot be sure that a sufficiently broad base of consumers will continue to use the Internet as a medium for commerce. Convincing our clients to offer real-time sales, marketing and customer service technology may be difficult.
 
The continuation of the Internet as a viable commercial marketplace is subject to a number of factors, including:
 
·   continued growth in the number of users;
 
·   concerns about transaction security;
 
·   continued development of the necessary technological infrastructure;
 
·   development of enabling technologies;
 
·   uncertain and increasing government regulation; and
 
·   the development of complementary services and products.
 
We depend on the continued viability of the infrastructure of the Internet.
 
To the extent that the Internet continues to experience growth in the number of users and frequency of use by consumers resulting in increased bandwidth demands, we cannot assure you that the infrastructure for the Internet will be able to support the demands placed upon it. The Internet has experienced outages and delays as a result of damage to portions of its infrastructure. Outages or delays could adversely affect online sites, email and the level of traffic on the Internet. We also depend on Internet service providers that provide our clients and Internet users with access to the LivePerson services. In the past, users have experienced difficulties due to system failures unrelated to our service. In addition, the Internet could lose its viability due to delays in the adoption of new standards and protocols required to handle increased levels of Internet activity. Insufficient availability of telecommunications services to support the Internet also could result in slower response times and negatively impact use of the Internet generally, and our clients’ sites (including the LivePerson pop-up dialogue windows) in particular. If the use of the Internet fails to grow or grows more slowly than expected, if the infrastructure for the Internet does not effectively support growth that may occur or if the Internet does not become a viable commercial marketplace, we may not maintain profitability and our business, results of operations and financial condition will suffer.
 

 
  28  

 

We may become subject to burdensome government regulation and legal uncertainties.
 
We are subject to federal, state and local regulation, and laws of jurisdictions outside of the United States, including laws and regulations applicable to computer software and access to or commerce over the Internet. Due to the increasing popularity and use of the Internet and various other online services, it is likely that a number of new laws and regulations will be adopted with respect to the Internet or other online services covering issues such as user privacy, freedom of expression, pricing, content and quality of products and services, taxation, advertising, intellectual property rights and information security. The nature of such legislation and the manner in which it may be interpreted and enforced cannot be fully determined and, therefore, such legislation could subject us and/or our clients or Internet users to potential liability, which in turn could have a material adverse effect on our business, results of operations and financial condition.
 
As a result of collecting data from live online Internet user dialogues, our clients may be able to analyze the commercial habits of Internet users. Privacy concerns may cause Internet users to avoid online sites that collect such behavioral information and even the perception of security and privacy concerns, whether or not valid, may indirectly inhibit market acceptance of our services. In addition, we or our clients may be harmed by any laws or regulations that restrict the ability to collect or use this data. The European Union and many countries within the E.U. have adopted privacy directives or laws that strictly regulate the collection and use of personally identifiable information of Internet users. The United States has adopted legislation which governs the collection and use of certain personal information. The U.S. Federal Trade Commission has also taken action against Web site operators who do not comply with their stated privacy policies. Furthermore, other foreign jurisdictions have adopted legislation governing the collection and use of personal information. These and other governmental efforts may limit our clients’ ability to collect and use information about their Internet users through our services. As a result, such laws and efforts could create uncertainty in the marketplace that could reduce demand for our services or increase the cost of doing business as a result of litigation costs or increased service delivery costs, or could in some other manner have a material adverse effect on our business, results of operations and financial condition.
 
For example, the LivePerson services allow our clients to capture and save information about Internet users, possibly without their knowledge. Additionally, our service uses a tool, commonly referred to as a “cookie,” to uniquely identify each of our clients’ Internet users. To the extent that additional legislation regarding Internet user privacy is enacted, such as legislation governing the collection and use of information regarding Internet users through the use of cookies, the effectiveness of the LivePerson services could be impaired by restricting us from collecting information which may be valuable to our clients. The foregoing could have a material adverse effect our business, results of operations and financial condition.
 
In addition to privacy legislation, any new legislation or regulation regarding the Internet, or the application of existing laws and regulations to the Internet, could harm us. Additionally, as we operate outside the U.S., the international regulatory environment relating to the Internet could have a material adverse effect on our business, results of operations and financial condition.
 
Security concerns could hinder commerce on the Internet.
 
User concerns about the security of confidential information online has been a significant barrier to commerce on the Internet and online communications. Any well-publicized compromise of security could deter people from using the Internet or other online services or from using them to conduct transactions that involve the transmission of confidential information. If Internet commerce is inhibited as a result of such security concerns, our business would be harmed.
 

 
  29  

 

Other Risks
 
Our executive officers, directors and stockholders who each own greater than 5% of the outstanding common stock will be able to influence matters requiring a stockholder vote.
 
Our executive officers, directors and stockholders who each own greater than 5% of the outstanding common stock and their affiliates, in the aggregate, beneficially own approximately 43.2% of our outstanding common stock. As a result, these stockholders, if acting together, will be able to significantly influence all matters requiring approval by our stockholders, including the election of directors and approval of significant corporate transactions. This concentration of ownership could also have the effect of delaying or preventing a change in control.
 
The future sale of shares of our common stock may negatively affect our stock price.
 
If our stockholders sell substantial amounts of our common stock, including shares issuable upon the exercise of outstanding options and warrants in the public market, or if our stockholders are perceived by the market as intending to sell substantial amounts of our common stock, the market price of our common stock could fall. These sales also might make it more difficult for us to sell equity securities in the future at a time and price that we deem appropriate. The number of shares of common stock subject to the registration statement we filed in January 2004, registering our issuance and sale from time to time of up to 4,000,000 shares of common stock, is much greater than the average weekly trading volume for our shares. No prediction can be made as to the effect, if any, that market sales of these or other shares of our common stock will have on the market price of our common stock.
 
Our stock price has been highly volatile and may experience extreme price and volume fluctuations in the future, which could reduce the value of your investment and subject us to litigation.
 
Fluctuations in market price and volume are particularly common among securities of Internet and other technology companies. The market price of our common stock has fluctuated significantly in the past and may continue to be highly volatile, with extreme price and volume fluctuations, in response to the following factors, some of which are beyond our control:
 
·   variations in our quarterly operating results;
 
·   changes in market valuations of publicly-traded companies in general and Internet and other technology companies in particular;
 
·   our announcements of significant client contracts, acquisitions and our ability to integrate these acquisitions, strategic partnerships, joint ventures or capital commitments;
 
·   our failure to complete significant sales;
 
·   additions or departures of key personnel;
 
·   future sales of our common stock;
 
·   changes in financial estimates by securities analysts; and
 
·   terrorist attacks against the United States or in Israel, the engagement in hostilities or an escalation of hostilities by or against the United States or Israel, or the declaration of war or national emergency by the United States or Israel.
 
In the past, companies that have experienced volatility in the market price of their stock have been the subject of securities class action litigation. We may in the future be the target of similar litigation, which could result in substantial costs and distract management from other important aspects of operating our business.
 

 
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Anti-takeover provisions in our charter documents and Delaware law may make it difficult for a third party to acquire us.
 
Provisions of our amended and restated certificate of incorporation, such as our staggered Board of Directors, the manner in which director vacancies may be filled and provisions regarding the calling of stockholder meetings, could make it more difficult for a third party to acquire us, even if doing so might be beneficial to our stockholders. In addition, provisions of our amended and restated bylaws, such as advance notice requirements for stockholder proposals, and applicable provisions of Delaware law, such as the application of business combination limitations, could impose similar difficulties. Further, provisions of our amended and restated certificate of incorporation relating to directors, stockholder meetings, limitation of director liability, indemnification and amendment of the certificate of incorporation and bylaws may not be amended without the affirmative vote of not less than 66.67% of the outstanding shares of our capital stock entitled to vote generally in the election of directors (considered for this purpose as a single class) cast at a meeting of our stockholders called for that purpose. Our amended and restated bylaws may not be amended without the affirmative vote of at least 66.67% of our Board of Directors or without the affirmative vote of not less than 66.67% of the outstanding shares of our capital stock entitled to vote generally in the election of directors (considered for this purpose as a single class) cast at a meeting of our stockholders called for that purpose.
 
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Currency Rate Fluctuations
 
Through September 30, 2004, our results of operations, financial condition and cash flows have not been materially affected by changes in the relative values of non-U.S. currencies to the U.S. dollar. The functional currency of our wholly-owned Israeli subsidiary, HumanClick Ltd., is the U.S. dollar. We do not use derivative financial instruments to limit our foreign currency risk exposure.
 
Collection Risk
 
Our accounts receivable are subject, in the normal course of business, to collection risks. We regularly assess these risks and have established policies and business practices to protect against the adverse effects of collection risks. We increased our allowance for doubtful accounts by $15,000 to approximately $79,000 in the nine months ended September 30, 2004, principally due to an increase in accounts receivable as a result of increased sales. During the year ended December 31, 2003, we increased our allowance for doubtful accounts by $15,000, principally due to an increase in accounts receivable as a result of increased sales, and we wrote off approximately $21,000 of previously reserved accounts, leaving a net allowance of $64,000 at December 31, 2003.
 
Interest Rate Risk
 
Our investments consist of cash and cash equivalents. Therefore, changes in the market’s interest rates do not affect in any material respect the value of the investments as recorded by us.
 
ITEM 4. CONTROLS AND PROCEDURES
 
Our management, including the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of LivePerson’s “disclosure controls and procedures,” as that term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of September 30, 2004. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures are effective to ensure that information required to be disclosed by LivePerson in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms, and to ensure that such information is accumulated and communicated to LivePerson’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
 
There were no changes in LivePerson’s internal control over financial reporting during the quarter ended September 30, 2004 identified in connection with the evaluation thereof by our management, including the Chief Executive Officer and Chief Financial Officer, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 

 
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PART II. OTHER INFORMATION
 
ITEM 1. LEGAL PROCEEDINGS
 
On or about December 2, 2002, MCI WorldCom Communications, Inc. filed a complaint against us in the United States District Court for the Southern District of New York, containing claims for unpaid invoices related to a contract with MCI for voice and data services. The complaint sought to recover approximately $761,000 plus interest. The District Court dismissed the action on our motion on May 29, 2003 because the contract contained a binding arbitration provision. The matter is presently pending for arbitration with JAMS in New York City in which we have denied liability.
 
Although we believe that we have meritorious defenses and intend to defend vigorously the matter described above, and believe that we have provided adequate reserves in connection with this claim, we cannot assure you that our defenses will be successful and, if they are not, that our ultimate liability in connection with this claim will not exceed our reserves or have a material adverse effect on our results of operations, financial condition, or cash flows.
 
In June 2003, James Ball d/b/a TalktoDealers.com filed a complaint against us and other unidentified persons in the Superior Court of the State of California for the County of Orange, containing claims for breach of contract and unjust enrichment. The complaint sought to recover approximately $1,152,000 per year from the time of LivePerson’s alleged breach in late 2002 or early 2003, plus interest, costs, attorneys’ fees, restitution and specific performance. This matter was settled in November 2004 for $250,000, and we reserved that amount as of September 30, 2004 (see note 2 to our unaudited interim condensed consolidated financial statements appearing elsewhere in this report).
 
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
Not applicable.
 
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
 
None.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
Not applicable.
 
ITEM 5. OTHER INFORMATION
 
None.
 
ITEM 6. EXHIBITS
 
The following exhibits are filed as part of this Quarterly Report on Form 10-Q:
 
  31.1 Certification by Chief Executive Officer pursuant to Exchange Act Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
  31.2 Certification by Chief Financial Officer pursuant to Exchange Act Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
  32.1 Certification by Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
  32.2 Certification by Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 

 

 
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SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
LIVEPERSON, INC.
(Registrant)
 
        
Date: November 15, 2004 By: /s/ ROBERT P. LOCASCIO
  Name: Robert P. LoCascio
  Title: Chief Executive Officer (duly authorized officer)
        
Date: November 15, 2004 By: /s/ TIMOTHY E. BIXBY
  Name: Timothy E. Bixby
  Title: President, Chief Financial Officer and Secretary (principal financial and accounting officer)


 
 
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EXHIBIT INDEX
 
 
EXHIBIT
 
31.1 Certification by Chief Executive Officer pursuant to Exchange Act Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
31.2 Certification by Chief Financial Officer pursuant to Exchange Act Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
32.1 Certification by Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
32.2 Certification by Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002