(1) SUMMARY OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES

(A) SUMMARY OF OPERATIONS

LivePerson, Inc. (the “Company” or “LivePerson”) provides online engagement solutions that facilitate real-time assistance and expert advice. Connecting businesses and independent service providers with individual consumers seeking help on the Web, the Company’s hosted software platform creates more relevant, compelling and personalized online experiences. The Company was incorporated in 1995 and commenced operations in 1996.

The Company’s primary revenue source is from the sale of the LivePerson services to businesses of all sizes. The Company also facilitates online transactions between independent service providers (“Experts”) who provide online advice to individual consumers (“Users”). Headquartered in New York City, the Company’s product development staff, help desk and online sales support are located in Israel. The Company also maintains sales and professional services offices in Atlanta, San Francisco and the United Kingdom.

(B) UNAUDITED CONDENSED CONSOLIDATED FINANCIAL INFORMATION

The accompanying condensed consolidated financial statements as of September 30, 2011 and for the three and nine months ended September 30, 2011 and 2010 are unaudited. In the opinion of management, the unaudited 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 consolidated financial position of LivePerson as of September 30, 2011, and the consolidated results of operations and cash flows for the interim periods ended September 30, 2011 and 2010. 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, 2010 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, 2010, included in the Company’s Annual Report on Form 10-K filed with the SEC on March 15, 2011.

The majority of the Company’s revenue is generated from monthly service revenues and related professional services from the sale of the LivePerson services. Because the Company provides its application as a service, the Company follows the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 605-10-S99, “Revenue Recognition” and ASC 605-25, “Revenue Recognition with Multiple-Element Arrangements.” The Company charges a monthly fee, which varies by type of service, the level of client usage and website traffic, and in some cases, the number of orders placed via the Company’s online engagement solutions.

For certain of the Company’s larger clients, the Company may provide call center labor through an arrangement with one or more of several qualified vendors. For most of these clients, the Company passes the fee it incurs with the labor provider and its fee for the hosted services through to its customers in the form of a fixed fee for each order placed via the Company’s online engagement solutions. For these Pay for Performance (“PFP”) arrangements, the Company recognizes revenue net of the labor provider’s fee in accordance with ASC 605-45, “Principal Agent Considerations,” due primarily to the fact that the call center labor vendor is the primary obligor with respect to the labor services provided. Additionally, the Company performs as an agent without risk of loss for collection and does not bear inventory risk with respect to the outsourced labor services. Finally, the Company does not provide any part of the labor services, has no latitude in establishing prices for the labor services and generally does not have discretion in selecting the vendor.

The majority of the Company’s larger clients also pay a professional services fee related to implementation. The Company defers these implementation fees and associated direct costs and recognizes them ratably over the expected term of the client relationship upon commencement of the hosting services. The Company may also charge professional service fees related to additional training, business consulting and analysis in support of the LivePerson services.

The Company also sells certain of the LivePerson services directly via Internet download. These services are marketed as LivePerson Pro and LivePerson Contact Center for small and mid-sized businesses (“SMBs”), 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 of LivePerson Pro and LivePerson Contact Center 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.

The Company recognizes monthly service revenue based upon the fee charged for the LivePerson services, provided that there is persuasive evidence of an arrangement, no significant Company obligations remain, collection of the resulting receivable is probable and the amount of fees to be paid is fixed or determinable. The Company’s service agreements typically have twelve month terms and, in some cases, are terminable or may terminate upon 30 to 90 days’ notice without penalty. When professional service fees add value to the customer on a standalone basis, the Company recognizes professional service fees upon completion and customer acceptance in accordance with FASB Accounting Standards Update 2009-13. This guidance establishes a selling price hierarchy for determining the selling price of a deliverable, which is based on: (a) vendor-specific objective evidence; (b) third-party evidence; or (c) estimates. If a professional services arrangement does not qualify for separate accounting, the Company recognizes the fees, and the related labor costs, ratably over a period of 48 months, representing the Company’s current estimate of the term of the client relationship.

For revenue generated from online transactions between Experts and Users, the Company recognizes revenue net of the Expert fees in accordance with ASC 605-45, “Principal Agent Considerations,” due primarily to the fact that the Expert is the primary obligor. Additionally, the Company performs as an agent without any risk of loss for collection, and is not involved in selecting the Expert or establishing the Expert’s fee. The Company collects a fee from the User and retains a portion of the fee, and then remits the balance to the Expert. Revenue from these transactions is recognized when there is persuasive evidence of an arrangement, no significant Company obligations remain, collection of the resulting receivable is probable and the amount of fees to be paid is fixed or determinable.

(D) STOCK-BASED COMPENSATION

The Company follows FASB ASC 718-10, “Stock Compensation,” which addresses the accounting for transactions in which an entity exchanges its equity instruments for goods or services, with a primary focus on transactions in which an entity obtains employee services in share-based payment transactions. ASC 718-10 requires measurement of the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). Incremental compensation costs arising from subsequent modifications of awards after the grant date must be recognized.

The following table summarizes stock-based compensation expense related to employee stock options under ASC 718-10 included in Company’s Statements of Income for the three and nine months ended September 30, 2011 and 2010:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2011		2010		2011		2010
Cost of revenue	$	212	$	245	$	758	$	655
Product development expense		417		360		1,299		1,022
Sales and marketing expense		427		413		1,206		971
General and administrative expense		680		411		1,688		954
Total stock based compensation included in operating expenses	$	1,736	$	1,429	$	4,951	$	3,602

The per share weighted average fair value of stock options granted during the three and nine months ended September 30, 2011 was $5.91 and $6.45, respectively. The per share weighted average fair value of stock options granted during the three and nine months ended September 30, 2010 was $3.87 and $3.82, 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 weighted average assumptions:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Dividend yield		0.0	%		0.0	%		0.0	%		0.0	%
Risk-free interest rate		0.9% - 1.5	%		2.6% - 3.0	%		0.9% - 3.7	%		2.6% - 3.8	%
Expected life (in years)		5.0			5.0			5.0			5.0

Historical volatility		60.1% - 60.6	%		61.8% - 61.9	%		60.1% - 61.5	%		60.3% - 61.9	%

During 1998, the Company established the Stock Option and Restricted Stock Purchase Plan (the “1998 Plan”). Under the 1998 Plan, the Board of Directors could issue incentive stock options or nonqualified stock options to purchase up to 5,850,000 shares of common stock. The 2000 Stock Incentive Plan (the “2000 Plan”) succeeded the 1998 Plan. Under the 2000 Plan, the options which had been outstanding under the 1998 Plan were incorporated in the 2000 Plan increasing the number of shares available for issuance under the plan by approximately 4,150,000, thereby reserving for issuance 10,000,000 shares of common stock in the aggregate.

The Company established the 2009 Stock Incentive Plan (the “2009 Plan”) as a successor to the 2000 Plan. Under the 2009 Plan, the options which had been outstanding under the 2000 Plan were incorporated into the 2009 Plan and the Company increased the number of shares available for issuance under the plan by 6,000,000, thereby reserving for issuance 19,567,744 shares of common stock in the aggregate. Options to acquire common stock granted thereunder have ten-year terms. As of September 30, 2011, approximately 13,639,000 shares of common stock were reserved for issuance under the 2009 Plan (taking into account all option exercises through September 30, 2011). As of September 30, 2011, there was approximately $27,247 of total unrecognized compensation cost related to nonvested share-based compensation arrangements. That cost, as of September 30, 2011, is expected to be recognized over a weighted average period of approximately 2.3 years.

In March 2000, the Company adopted the 2000 Employee Stock Purchase Plan with 450,000 shares of common stock initially reserved for issuance (the “2000 ESPP”). The 2000 ESPP expired on its terms on the last day of April 2010.

In June 2010, our stockholders approved the 2010 Employee Stock Purchase Plan with 1,000,000 shares of common stock initially reserved for issuance. As of September 30, 2011, approximately 947,000 shares of common stock were reserved for issuance under the Employee Stock Purchase Plan (taking into account all share purchases through September 30, 2011).

A summary of the Company’s stock option activity and weighted average exercise prices follows:

	Options			Weighted Average Exercise Price
Options outstanding at December 31, 2010		8,816,760		$	5.04
Options granted		3,171,600			12.15
Options exercised		(1,426,570	)		4.49
Options cancelled		(863,628	)		6.55
Options outstanding at September 30, 2011		9,698,162			7.32
Options exercisable at September 30, 2011		3,439,052		$	4.40

The total value of stock options exercised during the nine months ended September 30, 2011 was approximately $9,870. The total intrinsic value of options exercisable at September 30, 2011 was approximately $18,844. The total intrinsic value of nonvested options at September 30, 2011 is approximately $13,357. The total intrinsic value of all outstanding options at September 30, 2011 is $32,201

A summary of the status of the Company’s nonvested options as of December 31, 2010, and changes during the nine months ended September 30, 2011 is as follows:

	Options			Weighted Average Grant- Date Fair Value
Nonvested Options at December 31, 2010		5,719,012		$	3.13
Granted		3,171,600			6.45
Vested		(1,767,874	)		2.98
Cancelled		(863,628	)		3.59
Nonvested Options at September 30, 2011		6,259,110		$	4.80

(E) BASIC AND DILUTED NET INCOME PER SHARE

The Company calculates earnings per share (“EPS”) in accordance with the provisions of ASC 260-10 and the guidance of SEC Staff Accounting Bulletin (“SAB”) No. 98. Under ASC 260-10, 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 income attributable to common stockholders. Diluted EPS is calculated using the treasury stock method and 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 per common share for the three and nine months ended September 30, 2011 includes the effect of options to purchase 6,385,454 and 6,186,954 shares, respectively, of common stock with a weighted average exercise price of $4.85 and $4.73, respectively. Diluted net income per common share for the three and nine months ended September 30, 2010 includes the effect of options to purchase 6,044,108 and 6,094,108 shares, respectively, of common stock with a weighted average exercise price of $3.46 and $3.47, respectively.

A reconciliation of shares used in calculating basic and diluted earnings per share follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2011		2010		2011		2010
Basic		53,109,824		50,976,468		52,642,700		50,578,801
Effect of assumed exercised options		2,626,265		2,326,187		2,597,535		2,357,004
Diluted		55,736,089		53,302,655		55,240,235		52,935,805

(F) SEGMENT REPORTING

The Company accounts for its segment information in accordance with the provisions of ASC 280-10, “Segment Reporting.” ASC 280-10 establishes annual and interim reporting standards for operating segments of a company. ASC 280-10 requires disclosures of selected segment-related financial information about products, major customers, and geographic areas based on the Company’s internal accounting methods. The Company is organized into two operating segments for purposes of making operating decisions and assessing performance. The Business segment supports and manages real-time online interactions - chat, voice/click-to-call, email and self-service/knowledgebase and sells its products and services to global corporations of all sizes. The Consumer segment facilitates online transactions between Experts and Users and sells its services to consumers. Both segments currently generate their revenue primarily in the U.S. The chief operating decision-makers evaluate performance, make operating decisions, and allocate resources based on the operating income of each segment. The reporting segments follow the same accounting polices used in the preparation of the Company’s consolidated financial statements which are described in the summary of significant accounting policies. The Company allocates cost of revenue, sales and marketing and amortization of purchased intangibles to the segments, but it does not allocate product development expenses, general and administrative expenses and income tax expense because management does not use this information to measure performance of the operating segments. There are currently no inter-segment sales.

Summarized financial information by segment for the three months ended September 30, 2011, based on the Company’s internal financial reporting system utilized by the Company’s chief operating decision makers, follows:

	Consolidated		Corporate			Business		Consumer
Revenue:
Hosted services - Business	$	29,171	$	—		$	29,171	$	—
Hosted services - Consumer		3,561		—			—		3,561
Professional services		1,615		—			1,615		—
Total revenue		34,347		—			30,786		3,561
Cost of revenue		8,368		—			7,447		921
Sales and marketing		9,907		—			8,390		1,517
Amortization of intangibles		11		—			11		—
Unallocated corporate expenses		10,955		10,955			—		—
Operating income (loss)	$	5,106	$	(10,955	)	$	14,938	$	1,123

Summarized financial information by segment for the three months ended September 30, 2010, based on the Company’s internal financial reporting system utilized by the Company’s chief operating decision makers, follows:

	Consolidated		Corporate			Business		Consumer
Revenue:
Hosted services - Business	$	23,468	$	—		$	23,468	$	—
Hosted services - Consumer		3,605		—			—		3,605
Professional services		1,148		—			1,148		—
Total revenue		28,221		—			24,616		3,605
Cost of revenue		7,595		—			6,658		937
Sales and marketing		8,289		—			6,673		1,616
Amortization of intangibles		83		—			11		72
Unallocated corporate expenses		8,118		8,118			—		—
Operating income (loss)	$	4,136	$	(8,118	)	$	11,274	$	980

Revenues attributable to domestic and foreign operations for the three months ended September 30, 2011 and 2010, follows:

	September 30,
	2011		2010
United States	$	25,873	$	21,894
United Kingdom		4,958		3,486
Other countries		3,516		2,841
Total revenue	$	34,347	$	28,221

Summarized financial information by segment for the nine months ended September 30, 2011, based on the Company’s internal financial reporting system utilized by the Company’s chief operating decision makers, follows:

	Consolidated		Corporate			Business		Consumer
Revenue:
Hosted services - Business	$	81,493	$	—		$	81,493	$	—
Hosted services - Consumer		10,954		—			—		10,954
Professional services		4,134		—			4,134		—
Total revenue		96,581		—			85,627		10,954
Cost of revenue		25,148		—			22,322		2,826
Sales and marketing		28,146		—			23,527		4,619
Amortization of intangibles		32		—			32		—
Unallocated corporate expenses		29,695		29,695			—		—
Operating income (loss)	$	13,560	$	(29,695	)	$	39,746	$	3,509

Summarized financial information by segment for the nine months ended September 30, 2010, based on the Company’s internal financial reporting system utilized by the Company’s chief operating decision makers, follows:

	Consolidated		Corporate			Business		Consumer
Revenue:
Hosted services - Business	$	66,204	$	—		$	66,204	$	—
Hosted services - Consumer		10,491		—			—		10,491
Professional services		3,232		—			3,232		—
Total revenue		79,927		—			69,436		10,491
Cost of revenue		21,405		—			18,592		2,813
Sales and marketing		24,431		—			19,365		5,066
Amortization of intangibles		249		—			32		217
Unallocated corporate expenses		23,599		23,599			—		—
Operating income (loss)	$	10,243	$	(23,599	)	$	31,447	$	2,395

Revenues attributable to domestic and foreign operations for the nine months ended September 30, 2011 and 2010, follows:

	September 30,
	2011		2010
United States	$	73,820	$	61,400
United Kingdom		12,953		10,321
Other countries		9,808		8,206
Total revenue	$	96,581	$	79,927

Long-lived assets by geographic region follows:

	September 30, 2011		December 31, 2010
United States	$	29,214	$	29,352
Israel		13,443		13,736
United Kingdom		2,117		2,358
Total long-lived assets	$	44,774	$	45,446

(G) GOODWILL AND INTANGIBLE ASSETS

The changes in the carrying amount of goodwill for the nine months ended September 30, 2011 are as follows:

	Total		Business		Consumer
Balance as of December 31, 2010	$	24,015	$	15,991	$	8,024
Adjustments to goodwill:
Contingent earnout payments (see Note 3)		75		75		—
Balance as of September 30, 2011	$	24,090	$	16,066	$	8,024

The changes in the carrying amount of goodwill for the year ended December 31, 2010 are as follows:

	Total		Business		Consumer
Balance as of December 31, 2009	$	23,920	$	15,896	$	8,024
Adjustments to goodwill:
Contingent earnout payments (see Note 3)		95		95		—
Balance as of December 31, 2010	$	24,015	$	15,991	$	8,024

Intangible assets are summarized as follows (see Note 3):

Acquired Intangible Assets

	As of September 30, 2011
	Gross Carrying Amount		Weighted Average Amortization Period	Accumulated Amortization
Amortizing intangible assets:
Technology	$	6,199	3.8 years	$	5,409
Customer contracts		2,400	3.0 years		2,400
Trade names		630	3.0 years		630
Non-compete agreements		410	1.2 years		410
Patents		475	11.0 years		94
Other		235	3.0 years		235
Total	$	10,349		$	9,178

	As of December 31, 2010
	Gross Carrying Amount		Weighted Average Amortization Period	Accumulated Amortization
Amortizing intangible assets:
Technology	$	6,199	3.8 years	$	4,489
Customer contracts		2,400	3.0 years		2,400
Trade names		630	3.0 years		630
Non-compete agreements		410	1.2 years		410
Patents		475	11.0 years		61
Other		235	3.0 years		235
Total	$	10,349		$	8,225

Amortization expense is calculated on a straight-line basis over the estimated useful life of the asset. Aggregate amortization expense for intangible assets was $318 and $953 for the three and nine months ended September 30, 2011, respectively, and $390 and $1,168 for the three and nine months ended September 30, 2010, respectively. Estimated amortization expense for the next five years is: $77 in 2011, $306 in 2012, $306 in 2013, $240 in 2014, $43 in 2015 and $199 thereafter.

(H) RECENTLY ISSUED ACCOUNTING STANDARDS

In September 2011, the FASB issued Accounting Standards Update (ASU) No. 2011-08, Intangibles—Goodwill and Other (Topic 350): Testing Goodwill for Impairment. This ASU is intended to simplify how entities test goodwill for impairment. ASU 2011-08 permits an entity to first assess qualitative factors to determine whether it is "more likely than not" that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350, Intangibles-Goodwill and Other. The more-likely-than-not threshold is defined as having a likelihood of more than 50%. This update is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued. The Company has elected early adoption of this update and it had no impact on its consolidated financial statements.

In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income which requires an entity to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present total other comprehensive income, the components of other comprehensive income and the total of comprehensive income. This update, which should be applied retrospectively, is effective for annual periods beginning after December 15, 2011. The Company is still evaluating whether to present other comprehensive income in a single continuous statement of comprehensive income or in two separate but consecutive statements.

In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. This ASU represents the converged guidance of the FASB and the IASB (the Boards) on fair value measurement. The collective efforts of the Boards and their staffs, reflected in ASU 2011-04, have resulted in common requirements for measuring fair value and for disclosing information about fair value measurements, including a consistent meaning of the term “fair value.” The Boards have concluded the common requirements will result in greater comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with U.S. GAAP and IFRSs. The amendments to the FASB Accounting Standards Codification (Codification) in this ASU are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. Early application by public entities is not permitted. The Company is currently assessing the impact of this update on its consolidated financial statements.