(1) SUMMARY OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES

(A) SUMMARY OF OPERATIONS

LivePerson, Inc. (the “Company” or “LivePerson”) provides online engagement solutions offering a cloud-based platform which enables businesses to proactively connect with consumers through chat, voice, and content delivery, across multiple channels and screens, including websites, social media, and mobile devices. The Company’s engagements are driven by insights derived from a broad set of consumer and business data, including historical, behavioral, operational, and third party data. Each engagement is based on proprietary analytics and a real-time understanding of consumer needs and business objectives. The Company’s products, coupled with its domain knowledge and industry expertise, have been proven to maximize the effectiveness of the online channel — by increasing sales, as well as consumer satisfaction and loyalty ratings for their customers, while also enabling their customers to reduce consumer service costs.

LivePerson monitors and analyzes valuable online consumer behavioral data on behalf of their customers. Spanning the breadth of an online visitor session starting from an initial keyword search, through actions on their customer’s website, and even into a shopping cart and an executed sale, this data enables the Company to develop unique insights into consumer behavior during specific transactions within a customer’s user base.

The Company’s primary revenue source is from the sale of LivePerson services to businesses of all sizes. The Company also offers an online marketplace that connects independent service providers (“Experts”) who provide information and knowledge for a fee via real-time chat with individual consumers (“Users”).

LivePerson was incorporated in the State of Delaware in November 1995 and the LivePerson service was introduced in November 1998. In April 2000, the company completed an initial public offering and is currently traded on the Nasdaq and the Tel Aviv Stock Exchange. LivePerson is headquartered in New York City with offices in Atlanta, San Francisco, London, Melbourne, and Tel Aviv.

(B) UNAUDITED CONDENSED CONSOLIDATED FINANCIAL INFORMATION

The accompanying condensed consolidated financial statements as of June 30, 2012 and for the three and six months ended June 30, 2012 and 2011 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 June 30, 2012, and the consolidated results of operations, comprehensive income and cash flows for the interim periods ended June 30, 2012 and 2011. 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, 2011 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, 2011, included in the Company’s Annual Report on Form 10-K filed with the SEC on March 13, 2012.

(C) REVENUE RECOGNITION

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 customer 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 customers, the Company may provide call center labor through an arrangement with one or more of several qualified vendors. For most of these customers, 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 customers 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 customer 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 customer 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 and 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 six months ended June 30, 2012 and 2011:

	Three Months Ended June 30,				Six Months Ended June 30,
	2012		2011		2012		2011
Cost of revenue	$	388	$	248	$	701	$	546
Product development expense		789		441		1,399		881
Sales and marketing expense		739		443		1,291		779
General and administrative expense		722		547		1,403		1,008
Total stock based compensation included in operating expenses	$	2,638	$	1,679	$	4,794	$	3,214

The per share weighted average fair value of stock options granted during the three and six months ended June 30, 2012 was $8.29 and $7.24, respectively. The per share weighted average fair value of stock options granted during the three and six months ended June 30, 2011 was $7.07 and $6.97, 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 June 30,						Six Months Ended June 30,
	2012			2011			2012			2011
Dividend yield		0.0	%		0.0	%		0.0	%		0.0	%
Risk-free interest rate		0.72% - 0.84	%		2.9% - 3.5	%		0.72% - 0.87	%		2.9% - 3.7	%
Expected life (in years)		5.0			5.0			5.0			5.0
Historical volatility		60.6% -60.7	%		60.7% - 61.5	%		60.3% -60.8	%		60.7% - 61.5	%

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 (as amended and restated, 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. The Company amended the 2009 stock incentive plan (the “Amended 2009 Plan”) effective June 7, 2012. The Amended 2009 Plan increased the number of shares authorized for issuance under the plan by an additional 4,250,000, thereby reserving for issuance 23,817,744 shares of common stock in the aggregate. Options to acquire common stock granted thereunder have ten-year terms. As of June 30, 2012, approximately 11,427,000 shares of common stock were reserved for issuance under the 2009 Plan (taking into account all option exercises through June 30, 2012). As of June 30, 2012, there was approximately $28,198 of total unrecognized compensation cost related to nonvested share-based compensation arrangements. That cost is expected to be recognized over a weighted average period of approximately 2.1 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 June 30, 2012, approximately 899,000 shares of common stock were reserved for issuance under the Employee Stock Purchase Plan (taking into account all share purchases through June 30, 2012).

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, 2011		8,843,413		$	7.91
Options granted		1,120,300			14.15
Options exercised		(1,388,890	)		4.81
Options cancelled		(363,083	)		9.00
Options outstanding at June 30, 2012		8,211,740			9.24
Options exercisable at June 30, 2012		2,774,457		$	5.89

The total value of stock options exercised during the six months ended June 30, 2012 was approximately $13,739. The total intrinsic value of options exercisable at June 30, 2012 was approximately $36,071. The total intrinsic value of nonvested options at June 30, 2012 was approximately $44,206. The total intrinsic value of all outstanding options at June 30, 2012 was $80,277.

A summary of the status of the Company’s nonvested shares as of December 31, 2011, and changes during the six months ended June 30, 2012 is as follows:

	Shares			Weighted Average Grant Date Fair Value
Nonvested Shares at December 31, 2011		6,038,014		$	5.04
Granted		1,120,300			7.24
Vested		(1,362,573	)		4.14
Cancelled		(358,458	)		4.73
Nonvested Shares at June 30, 2012		5,437,283		$	5.76

(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 six months ended June 30, 2012 includes the effect of options to purchase 5,315,243 and 4,141,393 shares, respectively, of common stock with a weighted average exercise price of $6.87 and $5.60, respectively. Diluted net income per common share for the three and six months ended June 30, 2011 includes the effect of options to purchase 6,963,746 and 6,744,246 shares, respectively, of common stock with a weighted average exercise price of $4.90 and $4.77, respectively.

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

	Three Months Ended June 30,				Six Months Ended June 30,
	2012		2011		2012		2011
Basic		55,146,901		52,735,556		54,786,499		52,409,769
Effect of assumed exercised options		2,003,355		2,817,691		1,862,661		2,715,961
Diluted		57,150,256		55,553,247		56,649,160		55,125,730

(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 facilitates real-time online interactions – chat, voice, and content delivery across multiple channels and screens for 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 June 30, 2012, 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	$	32,151	$	—		$	32,151	$	—
Hosted services — Consumer		3,961		—			—		3,961
Professional services		2,393		—			2,393		—
Total revenue		38,505		—			34,544		3,961
Cost of revenue		8,492		—			7,939		553
Sales and marketing		13,017		—			11,624		1,393
Amortization of intangibles		11		—			11		—
Unallocated corporate expenses		16,561		16,561			—		—
Operating income (loss)	$	424	$	(16,561	)	$	14,970	$	2,015

Summarized financial information by segment for the three months ended June 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	$	26,736	$	—		$	26,736	$	—
Hosted services — Consumer		3,735		—			—		3,735
Professional services		1,380		—			1,380		—
Total revenue		31,851		—			28,116		3,735
Cost of revenue		8,685		—			7,688		997
Sales and marketing		9,379		—			7,822		1,557
Amortization of intangibles		11		—			11		—
Unallocated corporate expenses		10,402		10,402			—		—
Operating income (loss)	$	3,374	$	(10,402	)	$	12,595	$	1,181

Revenues attributable to domestic and foreign operations for the three months ended June 30, 2012 and 2011, follows:

	June 30,
	2012		2011
United States	$	29,225	$	24,311
United Kingdom		5,245		4,299
Other countries		4,035		3,241
Total revenue	$	38,505	$	31,851

Summarized financial information by segment for the six months ended June 30, 2012, 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	$	63,390	$	—		$	63,390	$	—
Hosted services — Consumer		7,809		—			—		7,809
Professional services		4,065		—			4,065		—
Total revenue		75,264		—			67,455		7,809
Cost of revenue		16,414		—			15,306		1,108
Sales and marketing		24,107		—			21,114		2,993
Amortization of intangibles		87		—			87		—
Unallocated corporate expenses		29,344		29,344			—		—
Operating income (loss)	$	5,312	$	(29,344	)	$	30,948	$	3,708

Summarized financial information by segment for the six months ended June 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	$	52,321	$	—		$	52,321	$	—
Hosted services — Consumer		7,393		—			—		7,393
Professional services		2,520		—			2,520		—
Total revenue		62,234		—			54,841		7,393
Cost of revenue		16,780		—			14,875		1,905
Sales and marketing		18,239		—			15,137		3,102
Amortization of intangibles		22		—			22		—
Unallocated corporate expenses		18,739		18,739			—		—
Operating income (loss)	$	8,454	$	(18,739	)	$	24,807	$	2,386

Revenues attributable to domestic and foreign operations for the six months ended June 30, 2012 and 2011, follows:

	June 30,
	2012		2011
United States	$	57,380	$	47,945
United Kingdom		10,121		7,994
Other countries		7,763		6,295
Total revenue	$	75,264	$	62,234

Long-lived assets by geographic region follows:

	June 30, 2012		December 31, 2011
United States	$	31,835	$	28,626
Israel		23,883		13,167
United Kingdom		2,179		2,249
Total long-lived assets	$	57,897	$	44,042

(G) GOODWILL AND INTANGIBLE ASSETS

The changes in the carrying amount of goodwill for the six months ended June 30, 2012 are as follows:

	Total		Business		Consumer
Balance as of December 31, 2011	$	24,090	$	16,066	$	8,024
Adjustments to goodwill:
Look.io acquisition (see Note 3)		1,082		1,082		—
Contingent earnout payments (see Note 3)		77		77		—
Balance as of June 30, 2012	$	25,249	$	17,225	$	8,024

The changes in the carrying amount of goodwill for the year ended December 31, 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 December 31, 2011	$	24,090	$	16,066	$	8,024

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

Acquired Intangible Assets

	As of June 30, 2012
	Gross Carrying Amount		Weighted Average Amortization Period		Accumulated Amortization
Amortizing intangible assets:
Technology	$	19,882		3.6 years	$	5,607
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		125
Other		235		3.0 years		235
Total	$	24,032			$	9,407

	As of December 31, 2011
	Gross Carrying Amount		Weighted Average Amortization Period		Accumulated Amortization
Amortizing intangible assets:
Technology	$	6,199		3.8 years	$	5,474
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		105
Other		235		3.0 years		235
Total	$	10,349			$	9,254

Amortization expense is calculated on a straight-line basis over the estimated useful life of the asset. Aggregate amortization expense for intangible assets was $77 and $153 for the three and six months ended June 30, 2012, respectively, and $318 and $635 for the three and six months ended June 30, 2011, respectively. Estimated amortization expense for the next five years and thereafter is: $874 in 2012, $4,448 in 2013, $3,661 in 2014, $2,743 in 2015, $2,743 in 2016 and $156 thereafter.

(H) RECENTLY ISSUED ACCOUNTING STANDARDS

In December 2011, the FASB issued ASU No. 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. This ASU is intended to provide enhanced disclosures that will enable users of its financial statements to evaluate the effect or potential effect of netting arrangements on an entity’s financial position. This includes the effect or potential effect of rights of setoff associated with an entity’s recognized assets and recognized liabilities within the scope of this update. The amendments require enhanced disclosures by requiring improved information about financial instruments and derivative instruments that are either (1) offset in accordance with either Section 210-20-45 or Section 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset in accordance with either Section 210-20-45 or Section 815-10-45. An entity is required to apply this amendment for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. ASU No. 2011-11 relates specifically to disclosures, it will not have an impact on the Company’s consolidated financial 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. This update did not have an impact on the Company’s consolidated financial statements.