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LIVEPERSON INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) General You should read the following discussion of our financial condition and results of operations in conjunction with the financial statements and the notes thereto included elsewhere in this report. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this report, particularly in "Risk Factors." Overview LivePerson provides digital engagement solutions offering a cloud-based platform which enables businesses to pro-actively connect with consumers and an online marketplace providing information and knowledge. We are organized into two operating segments: Business and Consumer. 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 independent service providers ("Experts") and individual consumers ("Users") seeking information and knowledge for a fee via real-time chat. We were incorporated in the State of Delaware in November 1995 and the LivePerson service was introduced initially in November 1998. In order to sustain growth in these segments, our strategy is to expand our position as the leading provider of online engagement solutions that facilitate real-time assistance and expert advice. To accomplish this, we are focused on the following current initiatives: • Expanding Business with Existing Customers and Adding New Customers. We are expanding our sales capacity by adding enterprise and midmarket sales agents. We have also expanded our efforts to retain existing SMB customers through increased interaction with them during the early stages of their usage of our services. • Introducing New Products and Capabilities. We are investing in product marketing, research and development and executive personnel to support our expanding efforts to build and launch new products and capabilities to support existing customer deployments, and to further penetrate our total addressable market. These investments are initially focused in the areas of online marketing engagement and chat transcript text analysis. Over time, we expect to develop and launch additional capabilities that leverage our existing market position as a leader in proactive, intelligence-driven online engagement. • Expanding our International Presence. We continue to increase our investment in sales and support personnel in the United Kingdom, Asia-Pacific, Latin America and Western Europe, particularly France and Germany. We are also working with sales and support partners as we expand our investment in the Asia-Pacific region. We continue to improve the multi-language and translation capabilities within our hosted solutions to further support international expansion. Key Metrics Financial overview of the three and twelve months ended December 31, 2013 compared to the comparable periods in 2012 are as follows: • Revenue increased 10% and 13% to $46.9 million and $177.8 million in the three and twelve months ended December 31, 2013, respectively from $42.5 million and $157.4 million in the comparable periods in 2012. • Revenue from our Business segment increased 11% and 14% to $43.0 million and $162.7 million in the three and twelve months ended December 31, 2013, respectively from $38.8 million and $142.3 million in the comparable periods in 2012. • Gross profit margin remained flat at 76% in the three months ended December 31, 2013 and the comparable period in 2012. Gross profit margin decreased to 76% from 77% in the twelve months ended December 31, 2013, from the comparable period in 2012. • Cost and expenses increased 19% and 24% to $47.5 million and $182.3 million in the three and twelve months ended December 31, 2013, respectively from $40.0 million and $147.1 million in the comparable periods in 2012. • Net loss increased 147% to $0.7 million in the three months ended December 31, 2013 from net income of $1.5 million for the three months ended December 31, 2012. Net loss increased 155% to $3.5 million in the twelve months ended December 31, 2013 from net income of $6.4 million for the twelve months ended December 31, 2012. • Bookings increased 15% and 17% to $10.0 million and $34.7 million in the three and twelve months ended December 31, 2013, respectively, from $8.7 million and $29.7 million in the comparable periods in 2012. We include in our bookings metrics new contractual commitments from either new or existing midmarket and/or enterprise customers for recurring subscription based fees, but exclude from such amounts non-recurring fees such as one time implementation costs or one time consulting fees. The bookings metric generally does not include or represent usage 30-------------------------------------------------------------------------------- based and/or pay-for-performance based contracts, month-to-month contracts or transaction-based services. Accordingly, while we believe that bookings is a relevant metric in providing management with insight into certain recent activity in our business, there is no assurance that bookings amounts will be recognized as revenue in future periods, based on our revenue recognition policy, potential customer cancellations, delays in implementations or otherwise. • Average deal size for new bookings in the three months ended December 31, 2013 was $53,000, with average deal size for new customers of $44,000 and average deal size for existing customers requesting additional products or expanded access to current products of $55,000. Average deal size for new bookings in the three months ended December 31, 2012 was $49,000, with average deal size for new customers of $31,000 and average deal size for existing customers requesting additional products or expanded access to current products of $54,000. Similar to our bookings metric, average deal size generally represents new contractual arrangements with committed subscription or base fees from new or existing mid-market or enterprise customers, and does not capture usage and/or pay-for-performance based contracts or fees. Management uses average deal size, being a subset of bookings, as a relevant metric in providing management with insight into certain recent activity in our business. Critical Accounting Policies and Estimates Our consolidated financial statements 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 the carrying amount of goodwill, intangibles, stock-based compensation, valuation allowances for deferred income taxes, accounts receivable, the expected term of a customer 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. For further information on all of our significant accounting policies, see Note 1 of the Notes to Consolidated Financial Statements under Item 8. Revenue Recognition The majority of our revenue is generated from monthly service revenues and related professional services from the sale of the LivePerson services. Because we provide our application as a service, we follow the provisions of ASC 605-10-S99, "Revenue Recognition" and ASC 605-25, "Revenue Recognition with Multiple-Element Arrangements." We charge 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 our online engagement solutions. For certain of our larger customers, we may provide call center labor through an arrangement with one or more of several qualified vendors. For most of these customers, we pass the fee we incur with the labor provider and our fee for the hosted services through to our customers in the form of a fixed fee for each order placed via our online engagement solutions. For these Pay for Performance ("PFP") arrangements, we recognize 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, we perform as an agent without risk of loss for collection and do not bear inventory risk with respect to the outsourced labor services. Finally, we do not provide any part of the labor services, have no latitude in establishing prices for the labor services and generally do not have discretion in selecting the vendor. We also sell 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 our 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. We recognize 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. Our service agreements typically have twelve month terms and 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, we recognize professional service fees upon completion and customer acceptance in accordance 31 -------------------------------------------------------------------------------- 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) best estimated selling price. If a professional services arrangement does not qualify for separate accounting, we recognize the fees, and the related labor costs, ratably over the contracted period. For revenue generated from online transactions between Experts and Users, we recognize revenue net of Expert fees in accordance with ASC 605-45, "Principal Agent Considerations," due primarily to the fact that the Expert is the primary obligor. Additionally, we perform as an agent without any risk of loss for collection, and are not involved in selecting the Expert or establishing the Expert's fee. We collect a fee from the consumer and retain a portion of the fee, and then remit 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. Stock-Based Compensation We follow 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. As of December 31, 2013, there was approximately $30.1 million 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 2.0 years. Accounts Receivable Our customers are located primarily in the United States. We perform ongoing credit evaluations of our customers' financial condition (except for customers who purchase the LivePerson services by credit card 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. Although our large number of customers limits our concentration of credit risk we do have several large customers. If we experience a significant write-off from one of these large customers, it could have a material adverse impact on our consolidated financial statements. No single customer accounted for or exceeded 10% of our total revenue in 2013, 2012 or 2011. One customer accounted for approximately 12% and 15% of accounts receivable at December 31, 2013 and 2012, respectively. We increased our allowance for doubtful accounts by $0.5 million to approximately $1.2 million, principally due to an increase in the proportion of our receivables due from customers with greater credit risk. A large proportion of receivables are due from larger corporate customers that typically have longer payment cycles. Goodwill In accordance with ASC 350, "Goodwill and Other Intangible Assets," goodwill and indefinite-lived intangible assets are not amortized, but reviewed for impairment upon the occurrence of events or changes in circumstances that would reduce the fair value below its carrying amount. Goodwill is required to be tested for impairment at least annually. In September 2011, the FASB issued ASU No. 2011-08, Intangibles - Goodwill and Other (Topic 350). 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. The more-likely-than-not threshold is defined as having a likelihood of more than 50%. If it is determined that the fair value of a reporting unit is more likely than not to be less than its carrying value (including unrecognized intangible assets) than it is necessary to perform the second step of the goodwill impairment test. The second step of the goodwill impairment test is judgmental in nature and often involves the use of significant estimates and assumptions. Similarly, estimates and assumptions are used in determining the fair value of other intangible assets. These estimates and assumptions could have a significant impact on whether or not an impairment charge is recognized and also the magnitude of any such charge. We perform internal valuation analyses and consider other market information that is publicly available. Estimates of fair value are primarily determined using discounted cash flows and market comparisons. These approaches use significant estimates and assumptions including projected future cash flows (including timing), discount rates reflecting the risk inherent in future cash flows, perpetual growth rates, determination of appropriate market comparables and the determination of whether a premium or discount should be applied to comparables. In the third quarter of 2013, we determined that it is not more-likely that the fair value of the reporting units is less than their carrying amount. Accordingly, we did not perform the two-step goodwill impairment test. 32 -------------------------------------------------------------------------------- Impairment of Long-Lived Assets In accordance with ASC 360-10, "Accounting for the Impairment or Disposal of Long-Lived Assets," long-lived assets, such as property, plant and equipment and purchased intangibles subject to amortization are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. The amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset. The Company does not have any long-lived assets, including intangible assets, which it considered to be impaired. Revenue The majority of our revenue is generated from monthly service revenues and related professional services from the sale of the LivePerson services. We charge a monthly fee, which varies by service and customer usage. The majority of our larger customers also pay a professional services fee related to implementation. A large proportion of our revenue from new customers comes from large corporations. These companies typically have more significant implementation requirements and more stringent data security standards. Such customers also have more sophisticated data analysis and performance reporting requirements, and are likely to engage our professional services organization to provide such analysis and reporting on a recurring basis. Revenue from our Business segment accounted for 92% of total revenue for the year ended December 31, 2013. Revenue from our Business segment accounted for 90% and 89% of total revenue for the years ended December 31, 2012 and 2011, respectively. Revenue attributable to our monthly hosted Business services accounted for 92% of total Business revenue for the year ended December 31, 2013. Revenue attributable to our monthly hosted Business services accounted for 93% of total Business revenue for the year ended December 31, 2012. Revenue attributable to our monthly hosted Business services accounted for 94% of total Business revenue for the year ended December 31, 2011. Our service agreements typically have twelve month terms and, in some cases, are terminable or may terminate upon 30 to 90 days' notice without penalty. Given the time required to schedule training for our customers' operators and our customers' resource constraints, we have historically experienced a lag between signing a customer contract and recognizing revenue from that customer. Although this lag has typically ranged from 30 to 90 days, it may take more time between contract signing and recognizing revenue in certain situations. Revenue from our Consumer segment is generated from online transactions between Experts and Users is recognized net of Expert fees and accounted for approximately 8% of total revenue for the year ended December 31, 2013. Revenue generated from online transactions between Experts and Users accounted for approximately 10% and 11% of total revenue for the years ended December 31, 2012 and 2011, respectively. We also have entered into contractual arrangements that complement our direct sales force and online sales efforts. These are primarily with 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. Costs and Expenses Our cost of revenue consists of: • compensation costs relating to employees who provide customer support and implementation services to our customers; • compensation costs relating to our network support staff; • depreciation of certain hardware and software; • allocated occupancy costs and related overhead; • the cost of supporting our infrastructure, including expenses related to server leases, infrastructure support costs and Internet connectivity; • the credit card fees and related payment processing costs associated with the consumer and SMB services; and • amortization of certain intangibles. Our sales and marketing expenses consist of compensation and related expenses for sales personnel and marketing personnel, online marketing, allocated occupancy costs and related overhead, advertising, sales commissions, 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, legal and human resources personnel, allocated occupancy costs and related overhead, professional fees, provision for doubtful accounts and other general corporate expenses. 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. 33 -------------------------------------------------------------------------------- During 2013, we increased our allowance for doubtful accounts by approximately $0.5 million to approximately $1.2 million, principally due to an increase in the proportion of receivables due from customers with greater credit risk. A large proportion of receivables are due from larger corporate customers that typically have longer payment cycles. During 2012, we increased our allowance for doubtful accounts by $20,000 to approximately $0.7 million, principally due to an increase in accounts receivable as a result of increased sales and, to a lesser extent, to an increase in the proportion of receivables due from customers with greater credit risk. A large proportion of receivables are due from larger corporate customers that typically have longer payment cycles. 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. Non-Cash Compensation Expense The net non-cash compensation amounts for the years ended December 31, 2013, 2012 and 2011 consist of (amounts in thousands): 2013 2012 2011 Stock-based compensation expense related to ASC 718-10 $ 12,508 $ 10,715 $ 6,771 Results of Operations The Company is organized into two operating segments: Business and Consumer. 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 seeking information and knowledge for a fee via real-time chat. The following tables set forth our results of operations for the periods presented and as a percentage of our revenues for those periods. The period-to-period comparison of financial results is not necessarily indicative of future results. Year Ended December 31, 2013 2012 2011 (as a percentage of revenue) Consolidated Statements of Operations Data: (1) Revenue 100 % 100 % 100 % Costs and expenses: Cost of revenue 24 % 23 % 25 % Sales and marketing 35 % 32 % 29 % General and administrative 22 % 20 % 16 % Product development 20 % 19 % 15 % Amortization of purchased intangibles - % - % - % Total costs and expenses 103 % 93 % 85 % (Loss) income from operations (3 )% 7 % 15 % Other income (expense) - % - % - % (Loss) income before provision for (benefit from) income taxes (2 )% 7 % 14 % (Benefit from) provision for income taxes - % 3 % 5 % Net (loss) income (2 )% 4 % 9 % (1) Certain items may not total due to rounding. 34 --------------------------------------------------------------------------------Revenue Year Ended December 31, Year Ended December 31, 2013 2012 % Change 2012 2011 % Change (in thousands) (in thousands)Revenue by Segment: Business $ 162,714 $ 142,298 14 % $ 142,298 $ 118,567 20 % Consumer 15,091 15,111 - % 15,111 14,522 4 % Total $ 177,805 $ 157,409 13 % $ 157,409 $ 133,089 18 % Business revenue increased by 14% to $162.7 million for the year ended December 31, 2013, from $142.3 million for the year ended December 31, 2012. This increase is primarily attributable to revenue from existing customers who increased their services in the amount of approximately $12.2 million, net of cancellations; revenue from new customers in the amount of approximately $6.0 million; and to a lesser extent, to professional services revenue of approximately $2.2 million. Our current revenue growth has been impacted by the necessary lead time required to get our global sales team up to full capacity in anticipation of our roll out of the LiveEngage platform. In addition, our revenue growth has traditionally been driven by a mix of revenue from new customers as well as expansion from existing customers. Business revenue increased by 20% to $142.3 million for the year ended December 31, 2012, from $118.6 million for the year ended December 31, 2011. This increase is primarily attributable to revenue from existing customers who increased their use of our services in the amount of approximately $12.6 million, net of cancellations and, to a lesser extent, to revenue from new customers in the amount of approximately $8.6 million and an increase in professional services revenue of approximately $3.3 million. Our revenue growth has traditionally been driven by a mix of revenue from new customers as well as expanding business from existing customers. Consumer revenue remained at $15.1 million for the year ended December 31, 2013, from the year ended December 31, 2012. There was an increase in fees we charge experts that was offset by a decrease in chat minutes. Consumer revenue increased by 4% to $15.1 million for the year ended December 31, 2012, from $14.5 million for the year ended December 31, 2011. This increase is primarily attributable to an increase in gross revenue as a result of increased chat minutes. Cost of Revenue - Business Cost of revenue consists of compensation costs relating to employees who provide customer service to our customers, compensation costs relating to our network support staff, the cost of supporting our server and network infrastructure, and allocated occupancy costs and related overhead. Year Ended December 31, Year Ended December 31, 2013 2012 % Change 2012 2011 % Change ($ in thousands) ($ in thousands) Cost of revenue- business $ 40,132 $ 33,450 20 % $ 33,450 $ 29,793 12 % Percentage of total revenue 23 % 21 % 21 % 22 % Headcount (at period end) 208 234 (11 )% 234 140 67 % Cost of revenue increased by 20% to $40.1 million in 2013, from $33.5 million in 2012. This increase in expense is primarily attributable to an increase in total compensation and related costs for additional and existing customer service and network operations personnel in the amount of approximately $5.2 million, and an increase in amortization of purchased intangibles of approximately $1.4 million as a result of our acquisitions of Amadesa, lookIO and Engage Pty Ltd. This increase in cost of revenue was driven primarily by increased investment in more robust business continuity capabilities within our hosting facilities. In addition, costs related to data collection and storage have increased, as we have improved the scope and quality of the analytical reporting we provide to our larger customers. Cost of revenue increased by 12% to $33.5 million in 2012, from $29.8 million in 2011. This increase in expense is primarily attributable to an increase in total compensation and related costs for additional and existing customer service and network operations personnel in the amount of approximately $2.9 million, an increase for primary and backup server facilities and allocated overhead related to costs of supporting our server and network infrastructure of approximately $0.4 million as a result of increased revenue and an increase in amortization of purchased intangibles of approximately $0.4 million as a result of our acquisitions of Amadesa and LookIO in May 2012 and June 2012, respectively. 35 -------------------------------------------------------------------------------- Cost of Revenue - Consumer Cost of revenue consists of compensation costs relating to employees who provide customer service to Experts and Users, compensation costs relating to our network support staff, the cost of supporting our server and network infrastructure, credit card and transaction processing fees and related costs, and allocated occupancy costs and related overhead. Year Ended December 31, Year Ended December 31, 2013 2012 % Change 2012 2011 % Change ($ in thousands) ($ in thousands) Cost of revenue- consumer $ 2,423 $ 2,129 14 % $ 2,129 $ 3,402 (37 )% Percentage of total revenue 1 % 1 % 1 % 3 % Headcount (at period end) 18 17 6 % 17 19 (11 )% Cost of revenue increased by 14% to $2.4 million in 2013, from $2.1 million in 2012. This increase is primarily attributable to an increase in total compensation and related costs for existing customers service personnel in the amount of $0.2 million. Cost of revenue decreased by 37% to $2.1 million in 2012, from $3.4 million in 2011. This decrease is primarily attributable to the technology purchased intangible asset related to the Kasamba acquisition that was fully amortized as of September 30, 2011. Sales and Marketing - Business Our sales and marketing expenses consist of compensation and related expenses for sales and marketing personnel, as well as advertising, public relations, trade show exhibit expenses and allocated occupancy costs and related overhead. Year Ended December 31, Year Ended December 31, 2013 2012 % Change 2012 2011 % Change ($ in thousands) ($ in thousands) Sales and Marketing - Business $ 57,011 $ 44,087 29 % $ 44,087 $ 32,690 35 % Percentage of total revenue 32 % 28 % 28 % 25 % Headcount (at period end) 259 232 12 % 232 165 41 % Sales and marketing expenses increased by 29% to $57.0 million in 2013, from $44.1 million in 2012. This increase is primarily attributable to an increase in compensation and related costs for additional and existing sales and marketing personnel of approximately $12.2 million, to a lesser extent, an increase in advertising, public relations and trade show exhibit expenses of approximately $0.3 million, and an increase in allocated occupancy costs and related overhead in the amount of approximately $0.4 million. The increase in expense as compared to our revenue growth is primarily related to the investment in our global sales team and global expansion. In addition, over the last few years we have made investments in our LiveEngage product which we will begin to rollout in 2014. The increase also relates to our continued efforts to enhance our brand recognition and increase sales lead activity. Sales and marketing expenses increased by 35% to $44.1 million in 2012, from $32.7 million in 2011. This increase is primarily attributable to an increase in compensation and related costs for additional and existing sales and marketing personnel of approximately $10.0 million, and an increase in advertising, public relations and trade show exhibit expenses of approximately $1.1 million. This increase relates to our continued efforts to enhance our brand recognition and increase sales lead activity. Sales and Marketing - Consumer Our sales and marketing expenses consist of compensation and related expenses for marketing personnel, as well as online promotion and trade show exhibit expenses and allocated occupancy costs and related overhead. Year Ended December 31, Year Ended December 31, 2013 2012 % Change 2012 2011 % Change ($ in thousands) ($ in thousands) Sales and Marketing - Consumer $ 5,477 $ 5,527 (1 )% $ 5,527 $ 6,194 (11 )% Percentage of total revenue 3 % 4 % 4 % 5 % Headcount (at period end) 4 3 33 % 3 3 - % 36-------------------------------------------------------------------------------- Sales and marketing expenses remained flat at $5.5 million in 2013 and 2012. Sales and marketing expenses decreased by 11% to $5.5 million in 2012, from $6.2 million in 2011. This decrease is primarily attributable to a decrease in compensation and related costs and allocated overhead for marketing personnel in the amount of approximately $684,000 as a result of realigning the responsibilities of certain employees to the Business segment. General and Administrative Our general and administrative expenses consist primarily of compensation and related expenses for executive, accounting, legal, human resources and administrative personnel, professional fees and other general corporate expenses. Year Ended December 31, Year Ended December 31, 2013 2012 % Change 2012 2011 % Change ($ in thousands) ($ in thousands) General and administrative $ 39,968 $ 31,606 26 % $ 31,606 $ 21,044 50 % Percentage of total revenue 22 % 20 % 20 % 16 % Headcount (at period end) 88 78 13 % 78 67 16 % General and administrative expenses increased by 26% to $40.0 million in 2013, from $31.6 million in 2012. This increase is primarily attributable to an increase in compensation and related expenses for additional and existing accounting, legal and human resource personnel in the amount of approximately $4.1 million, an increase in accounting and other professional fees of approximately $1.5 million, an increase in rent expense of approximately $1.2 million and an increase in depreciation of $0.9 million. General and administrative expenses increased by 50% to $31.6 million in 2012, from $21.0 million in 2011. This increase is primarily attributable to increases in accounting and legal costs related to acquisitions and litigation in the amount of approximately $5.0 million, increases in costs related to additional and existing personnel in the amount of approximately $4.6 million and increases in other professional fees in the amount of approximately $1.0 million. Product Development Our product development expenses consist primarily of compensation and related expenses for product development personnel as well as allocated occupancy costs and related overhead and outsourced labor and expenses for testing new versions of our software. Year Ended December 31, Year Ended December 31, 2013 2012 % Change 2012 2011 % Change ($ in thousands) ($ in thousands) Product development $ 36,397 $ 30,051 21 % $ 30,051 $ 20,222 49 % Percentage of total revenue 20 % 19 % 19 % 15 % Headcount (at period end) 210 204 3 % 204 172 19 % Product development costs increased by 21% to $36.4 million in 2013, from $30.1 million in 2012. This increase is primarily attributable to an increase in compensation and related costs for additional and existing product development personnel of approximately $5.1 million as a result of our increased efforts to expand our product offerings, as well as an increase in outsourced labor expense of approximately $1.2 million, as a result of testing new versions of our software. We are increasing our investment in new product development efforts to expand future product offerings. We are also investing in partner programs that enable third-parties to develop value-added software applications for our existing and future customers. Product development costs increased by 49% to $30.1 million in 2012, from $20.2 million in 2011. This increase is primarily attributable to an increase in compensation and related costs for additional and existing product development personnel of approximately $8.3 million and, to a lesser extent, to an increase in outsourced labor expense of approximately $0.9 million as a result of testing new versions of our software. The increase relates to our continued efforts to expand future product offerings. We are also investing in partner programs that enable third-parties to develop value-added software applications for our existing and future customers. 37 --------------------------------------------------------------------------------Amortization of Purchased Intangibles Year Ended December 31, Year Ended December 31, 2013 2012 % Change 2012 2011 % Change ($ in thousands) ($ in thousands) Amortization of purchased intangibles $ 871 $ 218 300 % $ 218 $ 109 100 % Percentage of total revenue - % - % - % - % Amortization expense for purchased intangibles was $0.9 million for the year ended December 31, 2013 and relates primarily to acquisition costs recorded as a result of our acquisitions of Engage in November 2012, LookIO in June 2012, Amadesa in May 2012, NuConomy in April 2010 and to the purchases of patents in August 2009. Amortization expense was $0.2 million for the year ended December 31, 2012 and relates primarily to our acquisition of Engage in November 2012 and NuConomy in April 2010 and to the purchases of patents in August 2009. This increase is attributable to the acquisition costs recorded as a result of our acquisitions in 2012. Additional amortization expense in the amount of $1.8 million and $0.4 million is included in cost of revenue for the years ended December 31, 2013 and 2012, respectively. Amortization expense for purchased intangibles was $0.2 million for the year ended December 31, 2012 and relates primarily to acquisition costs recorded as a result of our acquisition of Engage in November 2012 and NuConomy in April 2010 and to the purchases of patents in August 2009. Amortization expense was $0.1 million for the year ended December 31, 2011 and relates primarily to acquisition costs recorded as a result of our acquisition of NuConomy in April 2010. The increase is attributable to the acquisition costs recorded as a result of our acquisition of Engage in November 2012. Additional amortization expense in the amount of $0.4 million and $0.9 million is included in cost of revenue for the years ended December 31, 2012 and 2011, respectively. The decrease is primarily attributable to the technology intangible asset related to the Kasamba acquisition that was fully amortized as of September 30, 2011. Other Income (Expense) Year Ended December 31, Year Ended December 31, 2013 2012 % Change 2012 2011 % Change ($ in thousands) ($ in thousands) Other income (expense) $ 337 $ 376 (10 )% $ 376 $ (485 ) (178 )% Other income was $0.3 million in the twelve months ended December 31, 2013 and 2012, respectively. Other income (expense) includes financial expense which is the result of currency rate fluctuations associated with the exchange rate movement of the U.S. dollar against the New Israeli Shekel, Pound Sterling, and the Euro. Other income includes interest income, which was $39,000 and $71,000 in the twelve months ended December 31, 2013 and 2012 respectively, and consists of interest earned on cash and cash equivalents. This decrease is primarily attributable to decrease in short term interest rates cash and cash equivalents. Other income was $0.3 million in the twelve months ended December 31, 2012. Other expense was $0.5 million in the twelve months ended December 31, 2011. Other income and expense is the result of currency rate fluctuations associated with the exchange rate movement of the U.S. dollar against the New Israeli Shekel. Interest income was $71,000 and $63,000 in the twelve months ended December 31, 2012 and 2011 respectively, and consists of interest earned on cash and cash equivalents. (Benefit From) Provision for Income Taxes Year Ended December 31, Year Ended December 31, 2013 2012 % Change 2012 2011 % Change ($ in thousands) ($ in thousands) (Benefit from) provision for income taxes $ (638 ) $ 4,362 (115 )% $ 4,362 $ 7,112 (39 )% For the year ended December 31, 2013, our effective tax rate was 15.4% resulting in a benefit from income taxes of $0.6 million. For the year ended December 31, 2012, our effective tax rate was 40.7% resulting in a provision for income taxes of $4.4 million. The decrease in effective tax rate is primarily due to a decrease in non-deductible expenses related to incentive stock options. For the year ended December 31, 2012, our effective tax rate was 40.7% resulting in a provision for income taxes of $4.4 million. For the year ended December 31, 2011, our effective tax rate was 37.1% resulting in a provision for income taxes of $7.1 million in 2011. The increase in effective tax rate is primarily attributable to an increase in non-deductible expenses related to incentive stock options as a proportion of taxable income. 38 -------------------------------------------------------------------------------- Net (Loss) Income We had net loss of $3.5 million in 2013 compared to net income of $6.4 million in 2012. Revenue increased approximately $20.4 million while operating expenses increased by approximately $35.2 million and the provision for (benefit from) income taxes decreased approximately $5.0 million contributing to a net decrease in net income of approximately $9.8 million. We had net income of $6.4 million in 2012 compared to net income of $12.0 million in 2011. Revenue increased $24.3 million while operating expenses increased by $33.6 million, other expense decreased approximately $0.9 million and the provision for income taxes decreased approximately $2.7 million, contributing to a net increase in net income of $5.7 million. Quarterly Results of Operations Data The following table sets forth, for the periods indicated, the Company's financial information for the eight most recent quarters ended December 31, 2013. In the Company's opinion, this unaudited information has been prepared on a basis consistent with the annual consolidated financial statements and includes all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the unaudited information for the periods presented. This information should be read in conjunction with the consolidated financial statements, including the related notes, included herein. For the Three Months Ended Dec 31, Sept. 30, June 30, March 31, Dec 31, Sept. 30, June 30, Mar. 31, 2013 2013 2013 2013 2012 2012 2012 2012 (in thousands, except share and per share data) Consolidated Statements of Operations Data (1): Revenue $ 46,888 $ 45,192 $ 43,229 $ 42,496 $ 42,475 $ 39,670 $ 38,505 $ 36,759 Costs and Expenses: Cost of revenue 11,213 10,597 10,612 10,134 10,128 9,036 8,492 7,923 Sales and marketing 16,369 16,141 15,499 14,478 12,795 12,713 13,017 11,089 General and administrative 10,388 9,508 9,835 10,238 8,823 7,316 9,342 6,125 Product development 9,306 10,023 9,047 8,021 8,170 8,005 7,219 6,657 Amortization of purchased intangibles 199 224 224 224 119 11 11 77 Total costs and expenses 47,475 46,493 45,217 43,095 40,035 37,081 38,081 31,871 (Loss) income from operations (587 ) (1,301 ) (1,988 ) (599 ) 2,440 2,589 424 4,888 Other income (expense) 73 209 20 34 221 41 (233 ) 347 (Loss) income before provision for (benefit from) income taxes (514 ) (1,092 ) (1,968 ) (565 ) 2,661 2,630 191 5,235 Provision for (benefit from) income taxes 194 (362 ) (138 ) (333 ) 1,169 1,030 51 2,112 Net (loss) income $ (708 ) $ (730 ) $ (1,830 ) $ (232 ) $ 1,492 $ 1,600 $ 140 $ 3,123 Net (loss) income per share of common stock: Basic $ (0.01 ) $ (0.01 ) $ (0.03 ) 0.00 $ 0.03 $ 0.03 0.00 $ 0.06 Diluted $ (0.01 ) $ (0.01 ) $ (0.03 ) 0.00 $ 0.03 $ 0.03 0.00 $ 0.06 Weighted-average shares used to compute net (loss) income per share Basic 54,209,685 54,046,161 54,806,694 55,864,045 55,892,061 55,688,824 55,146,901 54,419,498 Diluted 54,209,685 54,046,161 54,806,694 55,864,045 57,589,248 57,760,868 57,150,256 56,389,729 Liquidity and Capital Resources As of December 31, 2013, we had approximately $91.9 million in cash and cash equivalents, a decrease of approximately $11.4 million from December 31, 2012. This decrease is primarily attributable to cash used to repurchase our common stock and net cash used in investing activities relating to purchases of fixed assets related to the build-out of our co-location facility. This is partially offset by net cash provided by operating activities and, to a lesser extent, proceeds from the issuance of common stock in connection with the exercise of stock options by employees.We invest our cash in short-term money market funds. Net cash provided by operating activities was $17.0 million in the year ended December 31, 2013 and consisted of non-cash expenses related to ASC-718-10, depreciation and amortization of purchased intangibles and increases in accrued expenses and deferred revenue, partially offset by an increase in accounts receivable, deferred income taxes and accounts payable. Net cash provided by operating activities was $28.0 million in the year ended December 31, 2012 and consisted of net income, non-cash 39 -------------------------------------------------------------------------------- expenses related to ASC-718-10, depreciation and amortization of intangibles and increases in deferred revenue, accounts payable and accrued expenses, partially offset by an increase in accounts receivable, deferred income taxes and prepaid expenses. Net cash used in investing activities was $8.2 million in the year ended December 31, 2013 and was due primarily to the purchase of fixed assets for our co-location facilities. Net cash used in investing activities was $31.5 million in the year ended December 31, 2012 and was due primarily to our purchase of technology assets from Amadesa, our acquisitions of LookIO and Engage and the purchase of fixed assets for our co-location facilities and the build-out of new office space in New York. Net cash used in financing activities was $20.2 million in the year ended December 31, 2013 and consisted primarily of the repurchase of our common stock partially offset by the proceeds from the issuance of common stock in connection with the exercise of stock options by employees. Net cash provided by financing activities was $13.5 million in the year ended December 31, 2012 and consisted primarily of the proceeds from the issuance of common stock in connection with the exercise of stock options by employees and the excess tax benefit from exercise of employee stock options. We have incurred significant expenses to develop our technology and services, to hire employees in our customer service, sales, marketing and administration departments, and for the amortization of purchased 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 $0.1 million in the three month period ended March 31, 2004. We also incurred a net loss and negative cash flow from operations in the quarterly period ended March 31, 2013 and a net loss in the quarterly periods ended June 30, September 30, 2013, December 31, 2013. As of December 31, 2013, we had an accumulated deficit of approximately $85.3 million. These losses have been funded primarily through the issuance of common stock in our initial public offering in 2000 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 or acquire 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 years ended December 31, 2013 and 2012 was approximately $9.3 million and $7.4 million, respectively. As of December 31, 2013, our principal commitments were approximately $24.1 million under various operating leases, of which approximately $8.4 million is due in 2014. We currently expect that our principal commitments for the year ending December 31, 2014 will not exceed approximately $9.0 million in the aggregate. Our contractual obligations at December 31, 2013 are summarized as follows (amounts in thousands): Payments Due by Period Less Than More Than Contractual Obligations Total 1 Year 1 - 3 Years 3 - 5 Years 5 Years Operating leases $ 24,148 $ 8,374 $ 12,286 $ 3,084 $ 404 Total $ 24,148 $ 8,374 $ 12,286 $ 3,084 $ 404 Capital Expenditures Through December 31, 2012, we spent approximately $26.0 million related to the build-out and expansion of our co-location facilities in the U.S. and Europe to host the LivePerson and Consumer services. In 2013 we incurred additional costs related to the continued expansion of our co-location facilities and office build-outs of approximately $3.6 million. We expect to incur additional costs in 2014 related to the continued expansion of our co-location facilities and office build-outs to support our growth. Our total capital expenditures are not currently expected to exceed $11.0 million in 2014. We anticipate that our current cash and cash equivalents and cash from operations will be sufficient to fund these capital expenditures. 40 --------------------------------------------------------------------------------Indemnifications We enter into service and license agreements in the ordinary course of business. Pursuant to some of these agreements, we agree to indemnify certain customers from and against certain types of claims and losses suffered or incurred by them as a result of using our products. We also have agreements whereby our executive officers and directors are indemnified for certain events or occurrences while the officer or director is, or was serving, at our request in such capacity. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited; however, we have a directors and officers insurance policy that reduces our exposure and enables us to recover a portion of any future amounts paid. As a result of our insurance policy coverage, we believe the estimated fair value of these indemnification agreements is minimal. Currently, we have no liabilities recorded for these agreements as of December 31, 2013. Item 7A. Quantitative and Qualitative Disclosures About Market Risk Currency Rate Fluctuations As a result of the expanding scope of our Israeli operations, our currency rate fluctuation risk associated with the exchange rate movement of the U.S. dollar against the New Israeli Shekel ("NIS") has increased. For the year ended December 31, 2013, the U.S dollar appreciated approximately 1% as compared to the NIS. For the year ended December 31, 2013, expenses generated by our Israeli operations totaled approximately $52.0 million. We do not currently hedge our foreign currency risk exposure. We actively monitor the movement of the U.S. dollar against the NIS, Pound Sterling, Euro, AUS dollar and Japanese Yen and have considered the use of financial instruments, including but not limited to derivative financial instruments, which could mitigate such risk. If we determine that our risk of exposure materially exceeds the potential cost of derivative financial instruments, we may in the future enter in to these types of investments. The functional currency of our wholly-owned Israeli subsidiaries, LivePerson Ltd. (formerly HumanClick Ltd.) and Kasamba Ltd., is the U.S. dollar; the functional currency of our operations in the United Kingdom is the Pound Sterling; the functional currency of our operations in the Netherlands is the Euro; and the functional currency of our operations in Australia is the Australian Dollar. 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. During 2013, we increased our allowance for doubtful accounts $0.5 million to approximately $1.2 million, principally due to an increase in the proportion of our receivables due from customers with greater credit risk. A large proportion of receivables are due from larger corporate customers that typically have longer payment cycles. During 2012, we increased our allowance for doubtful accounts $20,000 to approximately $0.7 million, principally due to an increase in accounts receivable as a result of increased sales and, to a lesser extent, to an increase in the proportion of our receivables due from customers with greater credit risk. 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. Inflation Rate Risk We do not believe that inflation has had a material effect on our business, financial conditions or results of operations. If our costs were to become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our inability or failure to do so could harm our business, financial condition and results of operations. 41-------------------------------------------------------------------------------- |