UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(MARK ONE)
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 29, 2001
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______ TO ______
Commission file number 0-27975
ELOYALTY CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 36-4304577
(State or other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
150 FIELD DRIVE , SUITE 250
LAKE FOREST, ILLINOIS 60045
(Address of Registrant's Principal Executive Offices)
Registrant's telephone number, including area code: (847) 582-7000
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $0.01 PER SHARE
INDICATE BY CHECK MARK WHETHER THE REGISTRANT: (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR SECTION 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO _
INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM
405 OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED, TO THE
BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION STATEMENTS
INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K OR ANY AMENDMENT TO THIS
FORM 10-K [X]
THE AGGREGATE MARKET VALUE OF COMMON STOCK HELD BY NON-AFFILIATES OF THE
REGISTRANT AS OF MARCH 15, 2002 (BASED UPON THE CLOSING PRICE PER SHARE OF
REGISTRANT'S COMMON STOCK ON MARCH 15, 2002 AS REPORTED BY THE NASDAQ NATIONAL
MARKET SYSTEM) WAS APPROXIMATELY $30,086,318.
THE NUMBER OF SHARES OF THE REGISTRANT'S COMMON STOCK, $0.01 PAR VALUE PER
SHARE, OUTSTANDING AS OF MARCH 15, 2002 WAS 6,296,990.
DOCUMENTS INCORPORATED BY REFERENCE
PORTIONS OF ELOYALTY'S PROXY STATEMENT FOR ITS 2002 ANNUAL MEETING OF
STOCKHOLDERS, TO BE FILED WITHIN 120 DAYS AFTER THE END OF ELOYALTY'S FISCAL
YEAR, ARE INCORPORATED HEREIN BY REFERENCE INTO PART III WHERE INDICATED.
TABLE OF CONTENTS
PART I
ITEM PAGE
---- ----
Item 1. Business 1
Item 2. Properties 5
Item 3. Legal Proceedings 5
Item 4. Submission of Matters to a Vote of
Security Holders 5
Item 4A. Executive Officers of the Company 6
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 7
Item 6. Selected Financial Data 8
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
Item 7A. Qualitative and Quantitative Disclosures about Market Risk 20
Item 8. Financial Statements and Supplementary Data 21
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 49
PART III
Item 10. Directors and Executive Officers of the Registrant 49
Item 11. Executive Compensation 49
Item 12. Security Ownership of Certain Beneficial Owners
and Management 49
Item 13. Certain Relationships and Related Transactions 49
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K 49
Signatures 51
Exhibit Index
i
PART I
ITEM 1. BUSINESS.
GENERAL
This Annual Report on Form 10-K (this "Form 10-K") contains
forward-looking statements that are based on current management expectations,
forecasts and assumptions. These include, without limitation, statements
containing the words "believes," "anticipates," "estimates," "expects," "plans,"
"intends," "projects," "future" and similar expressions, references to plans,
strategies, objectives and anticipated future performance, and other statements
that are not strictly historical in nature. These forward-looking statements are
subject to risks and uncertainties that could cause actual results to differ
materially from those expressed or implied by the forward-looking statements.
Such risks, uncertainties and other factors that might cause such a difference
include, without limitation, those noted under Factors That May Affect Future
Results or Market Price of Stock included in Item 7, Part II of this Form 10-K.
Readers should also carefully review the risk factors described in other
documents that eLoyalty Corporation files from time to time with the SEC.
Readers are cautioned not to place undue reliance on forward-looking
statements. They reflect opinions, assumptions and estimates only as of the date
they are made, and eLoyalty Corporation undertakes no obligation to publicly
update or revise any forward-looking statements in this report, whether as a
result of new information, future events or circumstances or otherwise.
INTRODUCTION
eLoyalty Corporation (together with its subsidiaries "eLoyalty," "we"
or the "Company") was incorporated in Delaware in May 1999 as a wholly-owned
subsidiary of Technology Solutions Company ("TSC"). The Company's business was
initiated in May 1994 as a call center business unit within TSC. This unit
within TSC was subsequently renamed the Enterprise Customer Management ("ECM")
business unit, and later the eLoyalty division. Since its inception and under
its various names, this business unit has developed management consulting and
technology capabilities in an effort to lead the development of, and stay at the
forefront of, the customer relationship management or "CRM" market, with the
specific focus on incorporating new technologies into CRM solutions.
While the growth of the Company's business primarily was organic during
its ownership by TSC, in 1997 TSC acquired and incorporated into its ECM unit
The Bentley Group, a business and operations consulting firm, for total
consideration of $17.5 million, and Geising International, a German-based
business consulting firm, for $1.4 million. Further, in 1996, TSC acquired Aspen
Consultancy Ltd., a privately owned consulting firm based in the United Kingdom
for $3.4 million. The purpose of each of these acquisitions was to expand the
range of the business's competencies in the CRM space in order to more
effectively serve its clients' needs.
In May 1999, TSC's ECM business unit was renamed eLoyalty and a new
subsidiary by the same name was formed in anticipation of a spin-off of
eLoyalty. In February 2000, TSC transferred the businesses of its eLoyalty
division to the Company and declared a dividend, payable to the stockholders of
record of TSC, based upon a ratio of one share of the Company's common stock,
par value of $.01 per share (the "Common Stock"), for every one share of TSC
Common Stock held. Effective February 15, 2000, all of the outstanding shares of
Common Stock were distributed to TSC's stockholders. eLoyalty became a separate
publicly traded company as of the same date.
On December 19, 2001, eLoyalty sold approximately 4.6 million shares of
a new class of 7% Series B Convertible Preferred Stock ("Series B stock"), par
value $.01 per share, in a private placement to funds managed by Technology
Crossover Ventures ("TCV") and Sutter Hill Ventures ("Sutter Hill") and in a
concurrent rights offering to eLoyalty stockholders. Immediately prior to the
closing of these transactions, (i) eLoyalty amended its certificate of
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incorporation to increase the number of its authorized shares of common stock
from 100 million to 500 million and its authorized shares of preferred stock
from 10 million to 40 million, and (ii) effected a one-for-ten reverse stock
split of its outstanding common stock (with a corresponding reduction in its
authorized shares of common stock, to 50 million). The private placement,
authorized share increase and reverse stock split were approved by eLoyalty's
stockholders on December 18, 2001 at a special meeting held for such purpose.
The Series B stock will accrue dividends at a rate of 7% per annum,
will be entitled to a preference upon liquidation and will be convertible into
shares of common stock on a one for one basis (subject to adjustment in the
future to give effect to certain actions) at the option of the holder beginning
June 19, 2002. In addition, the Series B stock generally votes with the
Company's common stock as a single class (subject to specified matters as to
which the Series B stock is entitled to a separate class vote) on the basis of
one vote per share (subject to adjustment in the future to give effect to
certain actions).
Approximately 1.9 million shares of Series B stock were sold to TCV for
gross proceeds of approximately $9.6 million. Approximately 1.3 million shares
of Series B stock sold to Sutter Hill for gross proceeds of approximately $6.4
million. Approximately 1.4 million shares of Series B stock were sold in the
rights offering to approximately 350 eLoyalty stockholders for gross proceeds of
approximately $7.3 million.
TCV and Sutter Hill were eLoyalty stockholders prior to these
transactions. In addition, Jay Hoag and Tench Coxe, eLoyalty directors, are (and
were prior to these transactions) affiliated with TCV and Sutter Hill,
respectively. The terms of the transactions were negotiated between TCV and
Sutter Hill, on the one hand, and the members of eLoyalty's board of directors
(other than Messrs. Hoag and Coxe) and its representatives, on the other hand.
As a result of these transactions, TCV and Sutter Hill own approximately 41% and
28%, respectively, of the outstanding Series B stock and approximately 26% and
14%, respectively, of the aggregate voting power of the Series B stock and
common stock.
In connection with the closing of the private placement, eLoyalty, TCV
and Sutter Hill entered into an Amended and Restated Investor Rights Agreement.
Under that agreement, eLoyalty must use its best efforts to have a Registration
Statement on Form S-3 for the shares of common stock issuable upon the
conversion of the Series B stock issued in the private placement, plus certain
previously owned TCV shares, declared effective within 180 days after closing.
eLoyalty will be required to maintain the effectiveness of the Registration
Statement until all of the common stock underlying the Series B stock issued in
the private placement can be sold in any and all three month periods under Rule
144 under the Securities Act of 1933 (without giving effect to Rule 144(k)). The
agreement also provides TCV and Sutter Hill with certain piggyback registration
rights.
Our executive offices are located at 150 North Field Drive, Suite 250,
Lake Forest, Illinois 60045 (telephone number 847-582-7000).
OVERVIEW
eLoyalty is a global management consulting and systems integration
organization focused exclusively on building customer loyalty solutions for our
clients. We offer a range of CRM-related services including evaluating and
developing business strategy, designing and implementing technical architecture,
selecting, implementing and integrating appropriate CRM software applications
and providing ongoing support for multi-vendor systems. We refer to the
solutions that we provide our clients to enhance their customer relations as
"loyalty solutions," in that they are designed to create long-term customer
loyalty measured by factors including an increase in repeat sales, reduction of
the cost of sales and increase in customer referrals. We help companies identify
and measure the impact of improved customer relationships on profitability. Our
customized solutions align many isolated customer contact channels, including
the Internet, e-mail, call centers, field sales and field service. The solutions
we design and implement enable our clients to sustain higher levels of success
with their customers.
Our revenues are generated primarily from professional services, which
are billed principally on a time and materials basis and, occasionally, on a
fixed fee basis. These services generally include the following:
- Evaluating our clients' efficiency and effectiveness in handling
customer interactions. We capture and analyze the
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performance measures of each customer interaction, including the
number of legacy systems used to handle the situation, interaction
time, reason for interaction and actions taken to resolve any
customer issues.
- Assisting our clients in identifying their most valuable customers
through detailed segmentation of their customer base. This allows
our clients to target high-value customers to receive special offers
or service levels.
- Performing detailed financial analysis to calculate the expected
return on investment for the implementation of our various loyalty
solutions. This process helps our clients establish goals,
alternatives and priorities and assigns client accountability
throughout resulting projects.
- Selecting the appropriate loyalty solution for our client. The
implementation of our loyalty solutions can lead to significant
organizational, structural, operational and staffing changes and we
assist our clients in determining the steps they need to take in
this regard.
- Implementing the technical aspects of our loyalty solutions,
including the integration of a variety of software applications from
third-party vendors and our own software.
In addition, we generate revenues from licensing of our proprietary
Loyalty Suite(TM) software, which ties together the critical components of the
loyalty solution. This software provides sophisticated real-time information
regarding a customer's various contacts with the client's organization, allowing
the client to handle each customer interaction in a consistent manner throughout
the enterprise. Other sources of revenue include maintenance and support of our
solutions, the provision of purpose-built hosting solutions and services
relating to e-PROFILE(TM) Internet banking products. These licensing and
"managed loyalty services" offerings, in the aggregate, accounted for less than
10% of our revenues in each of the last three years. Licensing revenues are
expected to decrease going forward based on our decision in 2002 to cease new
development of the Loyalty Suite(TM) software.
We operate in two primary business segments: North America (consisting
of the US and Canada) and International. In 2001, we globalized and centralized
our delivery, business development and infrastructure organizations and
processes. Accordingly, there are no material distinctions between the character
and nature of the two segments, other than financial results as discussed
herein.
For information regarding domestic and foreign revenues, operating
income and total assets, see Note Fifteen to the Consolidated Financial
Statements of eLoyalty, appearing under Item 8, Part II of this Form 10-K.
INTELLECTUAL PROPERTY RIGHTS
A majority of our clients require that we grant to them some or all
proprietary and intellectual property rights with respect to the original work
product resulting from our services, including the intellectual property rights
to any custom software developed for them. While each grant of proprietary and
intellectual property rights limits our ability to reuse work product components
with other clients, it is our practice to retain the rights in the underlying
core intellectual property on which it is based, including methodologies,
workplans and software. We regard these software and methodologies as
proprietary and intend to protect our rights, where appropriate, with registered
copyrights, patents, and trademarks, applicable trade secret laws and
contractual restrictions on disclosure and transferring title. Further, we
attempt to obtain from our clients an ownership interest or a license to permit
us to market custom software and other original materials to other clients.
These arrangements may be nonexclusive or exclusive, and licensors to us may
retain the right to sell products and services that compete with those of
eLoyalty. In addition, to protect our proprietary information, we rely upon a
combination of trade secret and common law, employee nondisclosure policies and
third-party confidentiality agreements.
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SEASONALITY
The Company typically experiences seasonal revenue and earnings
fluctuations globally in the fourth quarter, as the total number of billing days
is reduced due to holidays. Additionally, our European operations historically
have experienced decreased revenues and earnings in the third quarter because of
extended summer vacation periods.
CLIENTS
During fiscal 2001, our five and twenty largest clients accounted for
49% and 82%, respectively, of our revenues. Two clients accounted for more than
10% of our total revenues during the year, with each of Agilent Technologies and
UnitedHealth Group contributing 13% of total revenues for 2001. In June 2001,
Agilent Technologies notified us of the cancellation of the project on which we
and other third parties were engaged. For the fiscal year ended December 29,
2001, 31 clients each accounted for over $1 million of revenues. While our
focus, consistent with the focus of our services, is on developing long-term
relationships with our clients, the nature of its business is such that its
activities with specific clients will fluctuate periodically as individual
projects are initiated and progress through their life span. As a result, the
percentage of revenue contributed by any particular client can be expected to
vary, perhaps significantly, among periods.
COMPETITION
We operate in a highly competitive and rapidly changing market and
compete with a variety of organizations that offer services similar to ours. The
market includes a variety of participants that compete with us at various levels
of our business, including strategic consulting firms, systems integrators,
web-consulting firms, online agencies and firms that provide both consulting and
systems integration services. In our opinion, few competitors offer the full
range of CRM services that we can provide. We believe that our principal
competitors are the "Big 5" consultancies: Accenture, Cap Gemini Ernst & Young,
Deloitte Consulting, KPMG Consulting and PricewaterhouseCoopers.
Many of our competitors have longer operating histories, more clients,
longer relationships with their clients, greater brand or name recognition and
significantly greater financial, technical, marketing and public relations
resources than we do. As a result, our competitors may be in a better position
to respond quickly to new or emerging technologies and changes in client
requirements. They may also develop and promote their products and services more
effectively than we do. New market entrants also pose a threat to our business.
Existing or future competitors may develop or offer solutions that are
comparable or superior to ours at a lower price. In addition, several
competitors have announced their intention to offer a broader range of services
than they currently provide.
RESEARCH AND DEVELOPMENT
The market in which we operate is constantly evolving and we believe
that it is necessary to invest in research and development to remain
competitive. In 1998, we formally established our Loyalty Lab in Austin, Texas
as a center for our research and development group. Its activities include the
research and evaluation of emerging technologies, working with technology
partners to decrease the time and difficulty of integrating various CRM software
products, acting as a center for demonstrating loyalty solutions to our current
and prospective clients and training our employees on our solutions.
Our research and development expenditures for the years ended December
29, 2001, December 30, 2000, and December 31, 1999 were approximately $5.1
million, $8.8 million and $5.5 million, respectively.
EMPLOYEES
As of December 29, 2001, we employed 494 persons. Of the 494 employees,
358 were located in North America, with the balance in Europe and Australia. As
our business consists primarily of the provision of professional services, it is
inherently people intensive. We believe we have a satisfactory relationship with
our employees. Our average
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annualized voluntary turnover of field employees was 14% in 2001. None of our
employees are represented by a union. Most of our Vice Presidents and European
employees generally have employment agreements requiring three months' notice of
termination by us. In addition, the laws and regulations of the foreign
countries in which we operate may increase the cost of terminating employees in
those countries. We maintain various programs and strategies to retain and
recruit employees.
ITEM 2. PROPERTIES
Our principal physical properties consist of our leased headquarters in
Lake Forest, Illinois (north of Chicago), and additional leased office
facilities in other locations throughout the United States, including Atlanta,
GA; Dallas and Austin, TX; New York, NY; San Francisco, CA; and Washington,
D.C.; and in various international locations, including Toronto, (Ontario),
Canada; Frankfurt, Germany; Dublin, Ireland; and London, England. Our total
leased square footage is 42,000. We believe that our leased facilities are
appropriate for our current and anticipated business requirements.
ITEM 3. LEGAL PROCEEDINGS
As of the date of this report, we are not a party to any pending legal
proceedings, other than ordinary routine litigation or other legal proceedings
incidental to our business, none of which we believe would constitute material
legal proceedings for which disclosure is required under this item.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On December 18, 2001, we held a Special Meeting of Stockholders (the
"Special Meeting"). 36,241,116 shares of eLoyalty common stock were represented
at the Special Meeting, in person or by proxy. This represented more than a
majority of the shares of eLoyalty common stock outstanding on the record date
for the Special Meeting and therefore constituted a quorum. Each share present
was entitled to one vote.
The following actions were taken at the Special Meeting:
(1) Stockholders approved the sale of shares of eLoyalty's 7% Series B
Convertible Preferred Stock (the "Series B stock") in a private
placement to affiliates of TCV and Sutter Hill. 32,465,085 shares, or
nearly 90% of the shares voted, were voted in favor of the sale,
3,762,785 shares were voted against it and 13,246 shares abstained from
voting. In addition, taking into account only the 26,687,672 shares
that were represented at the meeting and held by persons not affiliated
with the purchasers (such affiliation determined in accordance with the
requirements set forth in the Stock Purchase Agreement for the private
placement), 22,911,641 shares, or nearly 86%, voted in favor of the
sale, 3,762,785 shares voted against and 13,246 shares abstained from
voting. As a result, our unaffiliated stockholders approved the Series
B stock sale as well.
(2) Stockholders approved an amendment to eLoyalty's Certificate of
Incorporation to increase the number of authorized shares of eLoyalty
common stock from 100,000,000 shares to 500,000,000 shares and to
increase the number of authorized shares of eLoyalty preferred stock
from 10,000,000 shares to 40,000,000 shares. 28,438,122 shares, or
approximately 55% of the shares outstanding, voted in favor of the
amendment, 7,789,788 shares voted against it and 13,206 shares
abstained from voting.
(3) Stockholders approved an amendment to eLoyalty's Certificate of
Incorporation to effect a one-for-ten stock combination, or reverse
stock split, of eLoyalty common stock and a corresponding reduction in
the number of authorized shares of eLoyalty common stock. 35,002,954
shares, or nearly 68% of the shares outstanding, voted for the reverse
stock split, 1,226,759 shares voted against, and 11,403 shares
abstained from voting.
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ITEM 4A. EXECUTIVE OFFICERS OF THE COMPANY
The following table includes the name, age (as of March 15, 2002),
current position and term of office of each of our executive officers.
Held
Name Age Current Position Since
Kelly D. Conway* 44 President and Chief Executive Officer 1999
Timothy J. Cunningham 48 Vice President, Chief Financial Officer and 1999
Corporate Secretary
Jackie L. Hilt 45 Vice President, Employee Loyalty 1999
Jay A. Istvan 42 Vice President, Strategy and Marketing 2001
Mark D. Kuchel 47 Vice President, Demand 1999
Steven C. Pollema 42 Vice President, Delivery and Operations 2001
Robert S. Wert 37 Vice President and General Counsel 2001
* Member of the Board of Directors
Except as required by individual employment agreements between
executive officers and the Company, there exists no arrangement or understanding
between any executive officer and any other person pursuant to which such
executive officer was elected. Each executive officer serves until his or her
successor is elected and qualified or until his or her earlier removal or
resignation.
The principal business experience of the executive officers for at
least the last five years is as follows:
Kelly D. Conway has been the President and Chief Executive Officer and
a Director of eLoyalty since its incorporation in May 1999. Mr. Conway joined
TSC in November 1993 as Senior Vice President, assumed the position of Executive
Vice President in July 1995 and became Group President in October 1998. From
1991 until joining TSC, Mr. Conway served as a Partner in the management
consulting firm of Spencer, Shenk and Capers. Prior thereto, he held various
management positions with Telcom Technologies, a manufacturer of automatic call
distribution equipment, including President and Chief Executive Officer from
1989 to 1991, and Vice President of Finance and Marketing from 1984 to 1989.
Timothy J. Cunningham has served as eLoyalty's Vice President, Chief
Financial Officer and Corporate Secretary since November 1999. From October 1998
until November 1999, he was the Vice President-Finance and Chief Financial
Officer of CTS Corporation, a publicly traded electronics and communications
company. Mr. Cunningham was Vice President-Finance of the Moore Document
Solutions division of Moore Corporation from July 1996 until September 1998, and
Group Controller for the ConAgra Refrigerated Foods group of ConAgra, Inc. from
1995 to 1996.
Jackie L. Hilt has been eLoyalty's Vice President of Employee Loyalty
since May 1999, with responsibility for recruiting and human resources functions
with a specific focus on employee relationships. Previously, Ms. Hilt had been
with TSC for more than ten years, most recently as the Senior Vice President in
charge of its international recruiting organization, a role she assumed in 1994.
Ms. Hilt currently is on a voluntary leave of absence from eLoyalty.
Jay A. Istvan has been the Vice President, Strategy and Marketing, of
eLoyalty since February 2001. Mr. Istvan was affiliated with The Boston
Consulting Group, Inc., a global strategic consulting firm, for more than
fourteen years
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prior to joining eLoyalty. He was a Vice President of Boston Consulting Group
from 1993 and was Midwest Regional Leader of its Healthcare practice from 1997
until joining eLoyalty and Regional Leader of its High Technology and
Convergence Practice from 1993 to 1997.
Mark D. Kuchel has been a Vice President of eLoyalty since February
2000, was the Area Practice Leader for the Eastern Region of North America from
November 2000 to August 2001 and has been Vice President, Demand since that
date. Prior to such time, Mr. Kuchel had been a Senior Vice President of TSC
since March 1996.
Steven C. Pollema has been Vice President, Delivery and Operations of
eLoyalty since August 2001, after joining eLoyalty in June 2001 as Senior Vice
President, Operations. Prior to joining eLoyalty, Mr. Pollema had been with
MarchFirst, Inc. and its predecessor, Whittman-Hart, Inc., since June 1997, most
recently as its President from March 2001 to May 2001. Prior to assuming the
office of President, Mr. Pollema was Executive Vice President-Global Operations
of MarchFirst from October 2000 through March 2001, Managing Executive --
Chicago Office/Region from October 1998 to October 2000, Solution Director --
Business Development from October 1997 to October 1998 and Partner -- Enterprise
Account Manager from July 1997 to October 1997. Prior to
MarchFirst/Whittman-Hart, Mr. Pollema was with Andersen Consulting, LLC, most
recently as an Associate Partner.
Robert S. Wert has been Vice President and General Counsel of eLoyalty
since October 2001. He joined eLoyalty in January 2001 as Vice President and
Senior Counsel. Prior to joining the Company, Mr. Wert was Associate General
Counsel and Assistant Secretary of Katy Industries, Inc., a publicly-held,
diversified holding company since August 1998. From 1989 to 1998, Mr. Wert was
with the Chicago law firm of Holleb & Coff, most recently as a Partner in its
Business Department from January 1997.
Please note that in February 2002, we ceased using the title Senior
Vice President for any of our officers. All persons previously holding that
title currently hold the title of Vice President. For simplicity, the current
office of each of the executive officers, other than Mr. Conway, is
characterized as that of Vice President with respect to his or her current role
in the organization. Certain of the executive officers were Senior Vice
Presidents at the time they assumed those roles.
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
Our Common Stock is traded on the National Market System under the
NASDAQ symbol ELOY. The following table sets forth, for the periods indicated,
the quarterly high and low prices of the common stock on the NASDAQ Stock
Market.
PRICE RANGE(1): High Low
----------------------------------------------------------------------------------------------------
Fiscal Year 2001
First Quarter $ 120.00 $ 22.50
Second Quarter 45.00 6.00
Third Quarter 10.20 4.00
Fourth Quarter 6.90 4.00
Fiscal Year 2000(2)
First Quarter (beginning February 16, 2000) $ 405.00 $ 184.40
Second Quarter 240.00 105.00
Third Quarter 181.30 98.80
Fourth Quarter 128.80 31.90
(1) Adjusted as necessary, to give effect to the one-for-ten reverse stock
split effected before the opening of business on December 19, 2001.
(2) We completed our 100% spin-off from TSC and began public trading on
February 16, 2000.
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There were approximately 467 owners of record of our Common Stock, par value
$0.01 per share, as of March 15, 2002.
On December 19, 2001, we raised an aggregate of $23.3 million of gross
cash proceeds in connection with the sale, pursuant to a private placement and
related rights offering, of shares of our Series B stock, par value $0.01 per
share. See "Introduction" in Item 1 Part I of this 10-K for more information
regarding the private placement. Each share of Series B stock is convertible
into one share of our common stock, at the option of the holder thereof,
beginning June 19, 2002. This conversion ratio is subject to adjustment in the
future in the event of certain transactions. The Series B stock will
automatically convert into our common stock at any time beginning June 19, 2002
if the last sale price of our common stock is at least five times the original
sale price per share of Series B stock ($5.10) for 30 consecutive trading days,
subject to certain limitations.
The private placement was made in reliance on the exemption from
registration under the Securities Act of 1933, as amended, afforded by Section
4(2) thereof and the rules promulgated under Regulation D thereunder. Prior to
the private placement, TCV and Sutter Hill were stockholders in our company and
the transaction was negotiated on a private basis between us and TCV and Sutter
Hill. In addition, in connection with the private placement, TCV and Sutter Hill
made certain representations to us regarding, among other things, their status
as "accredited investors" for purposes of the rules under Regulation D.
DIVIDENDS
Historically, we have not paid cash dividends on our common stock, and
do not expect to do so in the future. However, a cash dividend of approximately
$0.9 million is expected to be paid in July 2002 on the Company's redeemable
Series B stock. In addition, two semi-annual dividend payments of approximately
$0.8 million each are expected to be paid in 2003 on the Series B stock. The
amount of the dividend would be affected by any conversions of the Series B
stock into common stock, which is permitted at the option of the holder
beginning June 19, 2002.
ITEM 6. SELECTED FINANCIAL DATA.
The following tables summarize our selected financial data. This
information should be read in conjunction with Management's Discussion and
Analysis of Financial Condition and Results of Operations, and the financial
statements and notes thereto, which are included elsewhere in this Form 10-K.
The statements of operations data for the years ended December 29, 2001,
December 30, 2000 and December 31, 1999, for the seven month period ended
December 31, 1998 and for each of the years ended May 31, 1998 and 1997, and the
balance sheet data as of December 29, 2001, December 30, 2000, December 31, 1999
and 1998, and May 31, 1998 and 1997, below are derived from the audited
financial statements. The statements of operations data for the year ended
December 31, 1998 and for the seven month period ended December 31, 1997 are
derived from the unaudited financial statements. In the opinion of management,
the unaudited financial statements referred to above reflect all adjustments,
consisting of normal adjustments, necessary for a fair presentation of
eLoyalty's results of operations for the year ended December 31, 1998, and for
the seven month period ended December 31, 1997.
Certain reclassifications have been made in the statements of
operations for the years ended December 30, 2000, December 31, 1999 and 1998,
the seven month periods ended December 31, 1998 and 1997, and the fiscal years
ended May 31, 1998 and 1997 to conform to the 2001 presentation. In December
2000, we changed our fiscal year from a calendar year to a fiscal year ending on
the Saturday closest to the end of December. The fiscal year-end for 2001 was
December 29. We had previously changed our fiscal year-end from May 31 to
December 31, effective December 31, 1998. For comparative purposes, we have
included the statements of operations data for the year ended December 31, 1998,
and the seven month period ended December 31, 1997, which have been derived from
unaudited financial statements. In the opinion of management, the unaudited
financial statements for these periods reflect all adjustments, consisting of
normal adjustments, necessary for a fair presentation of eLoyalty's results of
operations for the year ended December 31, 1998 and the seven month period ended
December 31, 1997.
Page 8
The financial information for periods prior to February 15, 2000
reflect our results of operations and financial position as we operated within
TSC, and the financial information for periods subsequent to February 15, 2000
reflect our results of operations and financial position as we operated as a
separate, stand-alone, publicly-traded company. The financial information for
periods prior to February 15, 2000 may not necessarily reflect what the
financial position and results of operations would have been had we operated as
a separate, stand-alone, publicly-traded entity during such periods.
CONSOLIDATED STATEMENTS OF OPERATIONS DATA
For the
Seven Month
Period Ended For the
For the Years Ended December December Years Ended May
(In thousands, -------------------------------- ---------- ---------------
except per share data)(1) 2001 2000 1999 1998 1998 1997 1998 1997
-----------------------------------------------------------------------------------------------------------------------------
Revenues(2) $146,729 $236,498 $163,180 $117,616 $71,993 $48,806 $94,428 $48,261
Operating expenses:
Costs of services(2) (3) 113,282 150,691 103,306 72,406 44,569 30,922 58,348 26,585
Selling, general and
administrative(3) 58,832 73,411 39,377 33,915 21,342 13,536 25,851 14,612
Severance and
related costs 33,444 -- -- -- -- -- -- --
Research and development 5,091 8,821 5,494 3,770 3,029 1,453 2,461 1,749
Depreciation expense 5,683 2,372 1,502 601 421 128 308 131
Goodwill amortization 4,808 4,972 4,996 3,794 2,450 1,856 3,201 376
---------------------------------------------------------------------------------------------
Total operating expenses 221,140 240,267 154,675 114,486 71,811 47,895 90,169 43,453
---------------------------------------------------------------------------------------------
Operating (loss) income (74,411) (3,769) 8,505 3,130 182 911 4,259 4,808
Other income (expense) 1,654 2,921 (408) (391) (327) (14) (24) 15
---------------------------------------------------------------------------------------------
(Loss) income before
income taxes (72,757) (848) 8,097 2,739 (145) 897 4,235 4,823
Income tax
(benefit) provision (9,096) (424) 4,039 1,672 398 562 2,022 1,897
---------------------------------------------------------------------------------------------
Net (loss) income $(63,661) $ (424) $ 4,058 $ 1,067 $ (543) $ 335 $ 2,213 $ 2,926
Dividends and accretion related
to Series B preferred stock (3,576) -- -- -- -- -- -- --
---------------------------------------------------------------------------------------------
Net (loss) income available to
common stockholders $(67,237) $ (424) $ 4,058 $ 1,067 $ (543) $ 335 $ 2,213 $ 2,926
---------------------------------------------------------------------------------------------
Basic net (loss) income
per common share(4) $ (13.42) $ (0.09) $ 0.98 $ 0.26 $ (0.13) $ 0.08 $ 0.53 $ 0.71
Diluted net (loss) income
per common share(4) (5) $ (13.42) $ (0.09) $ 0.92 $ 0.25 $ (0.13) $ 0.07 $ 0.47 $ 0.63
(In millions)
Basic weighted average
shares outstanding(4) 5.01 4.82 4.14 4.14 4.14 4.14 4.14 4.14
Dilutive weighted average
shares outstanding 5.16 5.37 4.42 4.31 NA(6) 4.58 4.68 4.66
Page 9
Noncash compensation included in individual line items above: (7)
For the Years Ended December
2001 2000 1999
-------------------------------------------------------------------
Cost of services $ 841 $ 789 $ 319
Selling, general and
administrative 2,294 1,337 251
Research and
development 54 81 69
---------------------------------------------------------------
Total noncash
compensation $3,189 $2,207 $ 639
-------------------------------------------------------------------
(1) All share amounts have been adjusted to give effect to the one-for-ten
reverse stock split effected by the Company prior to the opening of
business on December 19, 2001.
(2) All periods presented have been adjusted to reflect adoption of EITF
D-103 requiring billable expenses to be classified as revenue.
(3) All periods presented have been adjusted to reflect the
reclassification of other costs of engageable project personnel from
Selling, General and Administrative to Cost of Services.
(4) In December 1999, eLoyalty issued 4.14 million shares to TSC. For
periods prior to February 15, 2000, basic earnings per share has been
computed based on the 4.14 million shares and diluted earnings per
share has been computed based on the 4.14 million shares plus the
estimated dilutive effect of common stock equivalents using the
"treasury stock" method. For periods subsequent to February 15, 2000,
basic earnings per share has been computed based on actual weighted
shares outstanding and dilutive earnings per share has been computed
based on the actual weighted shares outstanding plus the dilutive
effect of common stock equivalents using the "treasury stock" method.
(5) In periods of a loss, common stock equivalents were not included in
the calculation as they are antidilutive.
(6) Common stock equivalent information was not previously calculated for
this period when eLoyalty was part of TSC as they were antidilutive.
Subsequent to the spin-off eLoyalty does not maintain the information
to calculate common stock equivalents for this period.
(7) Not applicable for previous periods.
BALANCE SHEET DATA
As of
----------------------------------
December 29, December 30, As of December 31, As of May 31,
------------ ------------ ------------------ -------------------
(In thousands) 2001 2000 1999 1998 1998 1997
------------------------------------------------------------------------------------------------------------------
Cash and cash
equivalents $ 42,653 $ 41,138 $ 13,462 $ 4,411 $ 4,726 $ 4,130
Working capital $ 59,795 $ 109,934 $ 54,927 $ 26,231 $ 23,840 $13,506
Total assets $128,014 $ 184,618 $ 96,603 $ 63,904 $ 54,118 $24,188
Long-term obligations $ 3,390 -- -- -- -- --
Redeemable
preferred stock $ 19,499 -- -- -- -- --
Stockholders'
equity $ 77,347 $ 140,856 $ 73,615 $ 47,888 $ 40,893 $ 17,147
Page 10
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
The following Management's Discussion and Analysis and other parts of
this Form 10-K contain forward-looking statements that are based on current
management expectations, forecasts and assumptions. These include, without
limitation, statements containing the words "believes," "anticipates,"
"estimates," "expects," "plans," "intends," "projects," "future" and similar
expressions, references to plans, strategies, objectives and anticipated future
performance, and other statements that are not strictly historical in nature.
These forward-looking statements are subject to risks and uncertainties that
could cause actual results to differ materially from those expressed or implied
by the forward-looking statements. Such risks, uncertainties and other
associated factors that might cause such a difference include, without
limitation, those noted under "Factors That May Affect Future Results or Market
Price of Stock" included elsewhere in Item 7.
Readers are cautioned not to place undue reliance on forward-looking
statements. They reflect opinions, assumptions and estimations only as of the
date they are made, and we undertake no obligation to publicly update or revise
any forward-looking statements in this Form 10-K, whether as a result of new
information, future events or circumstances, or otherwise.
BACKGROUND
We are a global management consulting and systems integration
organization focused exclusively on building customer loyalty solutions for our
clients. We offer a broad range of customer relationship management ("CRM")
related services including business strategy, technical architecture, selecting,
implementing and integrating appropriate CRM software applications and providing
ongoing support for multi-vendor systems.
We spun off from Technology Solutions Company ("TSC") into a separate,
publicly-traded company on February 15, 2000 (the "spin-off"). Accordingly, the
statements of operations for periods subsequent to the spin-off reflect our
results as a stand-alone company. The statements of operations for periods prior
to the spin-off are presented as if eLoyalty operated as a separate entity, and
include a cost allocation of certain TSC general corporate expenses that were
not directly related to our operations. These costs were allocated
proportionately to us based on revenues and headcount.
PERFORMANCE OVERVIEW AND GENERAL OUTLOOK
Our consolidated revenues were $146.7 million in 2001. This represents
an approximate 38% decline as compared to 2000. Average revenues per billable
day for 2001 were $585,000, down from $938,000 for 2000. The decrease in
revenues is primarily due to a general economic slowdown that has contributed to
decreased spending on information technology. Beginning with this report,
revenue reflects adoption of Financial Accounting Standards Board (FASB)
Emerging Issues Task Force (EITF) D-103, requiring billable expenses to be
reported as revenue. Prior to the adoption of EITF D-103 billable expenses had
been recorded net of recoveries from customers as a component of cost of
services. All periods presented have been revised to reflect this change.
We have experienced declines during 2001 in the utilization rate of our
engageable field consultants, partially mitigated by our cost reduction
activities throughout this year. Utilization is defined as billed time as a
percentage of total available time. Average utilization was at 54% in the fourth
quarter 2001 versus 63% in the fourth quarter of 2000. Average utilization for
the year was 55% in 2001 versus 66% in 2000. We continue to experience pricing
pressures that have resulted in a decline of our average hourly billing rate
from $234 in the fourth quarter of 2000 to $202 in the fourth quarter of 2001.
We presently expect the current economic slowdown and related uncertain
client expenditure commitments and extended decision time frames to persist in
2002. Our revenue is expected to remain fairly constant for the first quarter of
2002 compared to the fourth quarter of 2001. We expect both our North American
segment (which has historically accounted for more than 80% of our consolidated
revenues) and our International segment to continue to suffer from a difficult
business environment.
Page 11
In response to this economic environment and demand slowdown, we have
undertaken a number of cost reduction activities, including headcount reductions
and office closures and downsizing. Annual savings resulting from these actions
are expected to be about $65 million and will substantially be realized in 2002.
These actions were taken in connection with a substantial reorganization of our
business and business operating processes. As a result of these activities, we
recognized a special pre-tax charge of $33.4 million (approximately $22.7
million after tax) in 2001. As a result of these combined 2001 actions, we
reduced our overall headcount by approximately 51%, from 1,018 total employees
at the end of fiscal 2000 to approximately 494 employees at December 29, 2001.
We expect substantially all severance and related costs to be paid out by the
end of 2002 pursuant to agreements entered into with affected employees, and
facility costs related to the office closures to be paid pursuant to contractual
lease terms through 2007. In addition we expect an estimated $1 million to $2
million pre-tax charge to be taken in the first quarter of 2002, relating
primarily to severance benefits associated with reductions in headcount. This
additional severance related charge is expected to be substantially paid out by
the end of 2002.
During the second quarter of 2001, we established a valuation allowance
against the benefit of certain international operating unit tax losses
previously recognized, and ceased recognizing the benefit of losses incurred by
these operating units. This decision was made following a company-wide review of
expected financial results by geography under various alternative scenarios and
the related assessments of recoverability of these net deferred tax assets in
light of the period over which they arose and the predictability of a near-term
return of international operating units to acceptable, continuing levels of
profitability. As of December 29, 2001, we had a valuation allowance of $14.1
million relating to these international operating unit tax losses.
Primarily as a result of the above-described business conditions and
the responsive cost reduction actions, we experienced a 2001 operating loss of
$74.4 million, compared to an operating loss of $3.8 million for fiscal 2000.
During 2001, we entered into a share purchase agreement with affiliates
of Technology Crossover Ventures and Sutter Hill Ventures, already stockholders
of our Company, under which these investors purchased $16.0 million of a new
series of preferred stock, a redeemable 7% Series B Convertible Preferred Stock
(the "Series B stock"), in a private placement. See the section titled
"Introduction" in Item 1, Part I of this Form 10-K for more information about
the private placement. In addition, we closed concurrently on a rights offering
pursuant to which our existing common stockholders purchased $7.3 million of the
Series B stock. We also effected a one-for-ten reverse split of our common stock
shortly before the closing of the private placement and rights offering. The
private placement, the reverse stock split and related changes to our capital
structure were approved by stockholders in a special meeting of stockholders
held December 18, 2001.
During the fourth quarter 2001, we offered our US employees the
opportunity to exchange certain of their options to purchase Common Stock for
restricted Common Stock on a one for one basis. For non-US employees, we offered
the opportunity to exchange certain of their options to purchase Common Stock
for the right to receive shares of our Common Stock, on a one for one basis,
subject to the terms and conditions of an installment stock award. See Note
Thirteen to our consolidated financial statements. Furthermore, in connection
with a new compensation program for our Vice Presidents, on February 28, 2002,
we issued additional shares of restricted Common Stock to our US Vice Presidents
and granted our non-US Vice Presidents the right to receive additional shares of
our Common Stock subject to the terms of an installment stock award. See Note
Eighteen to our consolidated financial statements.
Our revenues are generated primarily from professional services, which
are billed principally on a time and materials basis. We have on occasion,
contracted projects on a fixed fee basis. Revenues are recognized for time and
material engagements as services are rendered utilizing the
percentage-of-completion method.
Other revenue contributors include fees generated from Managed Loyalty
Services (including Loyalty Support(TM) services, purpose-built hosted solutions
and e-PROFILE(TM)). These revenues comprised 5% and 3% of revenues in 2001 and
2000, respectively. Revenues from sales of our Loyalty Suite(TM) software
decreased to 1% from 2% of revenues in 2001 and 2000, respectively, and are
expected to decrease further due to our decision in 2002 to cease new
development of this software.
Page 12
Our revenues from international operations primarily represent revenues
in Europe and Australia. International operations represented 18% and 12% of
revenues for the years ended December 29, 2001 and December 30, 2000,
respectively. While certain of our professionals remain in Australia to perform
services for an existing client, we have closed our Australia office and do not
anticipate near term additional projects in that country.
We typically experience seasonal fluctuations in our revenues and
earnings on a global basis in the fourth quarter because of the reduced number
of billing days due to holidays. In addition, we have historically experienced
decreases in revenues from our European operations in the third quarter because
of extended summer vacation periods. Although those decreases in revenues have
not been significant in the past, they may increase in the future.
Our most significant operating cost is cost of services associated with
projects, which are primarily comprised of labor costs including salaries,
fringe benefits and incentive compensation of engageable consultants. Cost of
services also includes employee costs for training, travel expenses, laptop
computer leases and other expenses of a billable and non-billable nature.
Selling, general and administrative expenses consist primarily of
salaries, incentive compensation and employee benefits for business development,
marketing, administrative personnel, plus a provision for uncollectible amounts.
Selling, general and administrative also includes expenses relating to
administrative and technical support services provided by TSC, which continued
to be provided after the spin-off in 2000 as part of a shared services
agreement. None of these services were provided by TSC in 2001.
Research and development expenses consist primarily of salaries,
incentive compensation and employee benefits for dedicated personnel, staff
recruiting costs, administrative costs, travel expenses and depreciation
expenses. Our Loyalty Lab(TM) is the center for our research and development
activities, and we believe it improves the effectiveness of our loyalty
solutions, allows us to work closely with emerging technology and serves as a
demonstration center for our clients' senior executives.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our management discussion and analysis of financial condition and
results of operations are based upon our consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States. The preparation of these financial statements
requires us to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosure of contingent
assets and liabilities. On an on-going basis, we evaluate our estimates,
including those related to the costs and timing of completion of client
projects, collectibility of customer accounts receivable, the timing and amounts
of expected payments associated with cost reduction activities, the
realizability of net deferred tax assets and contingencies and litigation. We
base our estimates on historical experience and on various other assumptions
that we believe to be reasonable under the circumstances. Actual results may
differ from these estimates under different assumptions or conditions.
We believe the following critical accounting policies affect more
significant judgments and estimates used in the preparation of our consolidated
financial statements.
We recognize revenue and profit from professional services performed
for clients as work progresses using the percentage-of-completion method.
Percentage of completion estimates are based on the ratio of actual hours
incurred to total estimated hours. We follow this method because we believe that
reasonably dependable estimates of the revenue and costs applicable to various
stages of a client project can be made. Revisions in profit estimates are
recorded in the period in which the facts that give rise to the revision become
known. We maintain allowances for doubtful accounts for estimated losses
resulting from the inability of our customers to make required payments and
customers indicating their intention to dispute their obligation to pay for
contractual services provided by us. If the financial condition of our customers
were to deteriorate, resulting in an impairment of their ability to make
payments, additional allowances may be required.
We have recorded an income tax valuation allowance to reduce our
international net deferred tax assets to zero representing the amount that is
considered more likely than not to be realized and have ceased recognizing any
future
Page 13
benefits. The decision to establish a valuation allowance was made following an
assessment of the recoverability of these net deferred tax assets in light of
current estimates of a near-term return of international operating units to
acceptable, continuing level of profitability. No valuation allowance has been
recorded at December 29, 2001 for US net deferred tax assets of $22.5 million as
it is considered more likely than not that these net assets will be realized
over the carryforward period. This conclusion was based on forecasts of future
financial results which indicate that we will return to profitability in fiscal
2002 and that the net deferred tax asset will be fully realized by 2004. The
amount of the US net deferred tax asset that is considered realizable could be
reduced in the near term through the recording of valuation allowances if
current estimates of the timing and amount of future taxable income during the
carryforward period are significantly revised or if we undergo an ownership
change for purposes of Section 382 of the Internal Revenue Code. In the event we
were to determine that we would be able to more likely than not realize deferred
tax assets for which valuation allowances had previously been provided, an
adjustment to the deferred tax asset would be required increasing income in the
period such determination was made.
We have recorded accruals for severance and related costs associated
with the cost reduction efforts undertaken during 2001. A substantial portion of
the accruals represents contractual severance for identified employees and is
not subject to significant revision. That portion of the accruals relating to
office closures and associated contractual lease obligations is based in part on
assumptions and estimates of the timing and amount of sublease rentals that are
affected by overall economic and local market conditions. To the extent
estimates of the success of our sublease efforts change in the future,
adjustments increasing or decreasing the related accruals will be recorded.
YEAR ENDED DECEMBER 29, 2001 COMPARED WITH THE YEAR ENDED DECEMBER 30, 2000
REVENUES
Our revenues decreased $89.8 million, or 38%, to $146.7 million in 2001
from $236.5 million in 2000. Revenues from professional fees decreased $84.6
million, or 38%, to $138.6 million in 2001 from $223.2 million in 2000. The
decrease in revenues is due to a weak economic environment that led to decreased
demand for the CRM services provided by us.
Revenues from Managed Loyalty Services decreased $0.5 million to $7.3
million in 2001 from $7.8 million in 2000. Managed Loyalty Services revenues
represented 5% and 3% of total revenues for the years ended December 29, 2001
and December 30, 2000, respectively. Revenues from software decreased $4.7
million to $0.8 million in 2001 from $5.5 million in 2000. Revenues from
international operations increased to approximately 18% of total revenues in
2001, compared to 12% in 2000.
COST OF SERVICES
Cost of services decreased $37.4 million, or 25%, to $113.3 million in
2001 from $150.7 million in 2000. This is due to a decrease in the number of our
engageable consultants to 387 as of December 29, 2001, for a decrease of 50%,
from 768 as of December 30, 2000. Cost of services as a percentage of revenues
increased to 77% in 2001 compared to 64% in 2000. This increase was primarily
due to lower utilization in 2001 versus 2000.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses decreased $14.6 million,
or 20%, to $58.8 million in 2001 from $73.4 million in 2000. This decrease is
primarily the result of the reduction of headcount and office closures in
response to the decline of revenue.
SEVERANCE AND RELATED COSTS
Severance and related costs increased to $33.4 million in 2001 compared
to none in 2000. This was the result of workforce reductions and facilities
closures in response to a decline in revenue and expected activity. Annual
savings resulting from these actions are expected to be $65 million.
Page 14
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses decreased $3.7 million, or 42%, to
$5.1 million in 2001 from $8.8 million in 2000. This decrease is primarily due
to lower investment in the Loyalty Lab, including headcount reductions.
DEPRECIATION
Depreciation expense increased to $5.7 million for 2001 compared to
$2.4 million in 2000. The $3.3 million increase is due to investments in
computer hardware and software that were established in North American and
International locations. The bulk of this system implementation occurred in 2000
when we built out our own infrastructure as a stand-alone company for US
operations, following the February 2000 spin-off from TSC.
GOODWILL AMORTIZATION
Goodwill amortization expense decreased slightly to $4.8 million in
2001 compared to $5.0 million in 2000. Goodwill amortization is primarily
attributable to the acquisition of The Bentley Group in 1997. Effective January
2002, we adopted SFAS 142 "Goodwill and Other Intangible Assets" which requires
that goodwill no longer be amortized effective January 2002.
OTHER INCOME (EXPENSE)
We recognized non-operating other income of $1.7 million in 2001
compared to $2.9 million in 2000. The $1.2 million decrease in non-operating
other income is primarily due to lower average invested cash balances and
yields, and increased interest expense on short-term borrowings.
INCOME TAX (BENEFIT) PROVISION
The effective tax rate declined year-over-year due to a $14.1 million
valuation allowance established for non-US net deferred tax assets. During the
second quarter of 2001, we established a valuation allowance against the benefit
of certain international operating unit tax losses previously recognized and
ceased recognizing the benefit of losses incurred by these operating units. We
continue to record the income tax benefit of US operating losses using
applicable statutory rates.
NET (LOSS) INCOME
We reported a net loss of $63.7 million for 2001 as compared with a net
loss of $0.4 million in 2000. We reported a net loss of $13.42 per share on a
diluted basis in 2001 versus a net loss of $0.09 per share in 2000.
YEAR ENDED DECEMBER 30, 2000 COMPARED WITH THE YEAR ENDED DECEMBER 31, 1999
REVENUES
Our revenues increased $73.3 million, or 45%, to $236.5 million in 2000
from $163.2 million in 1999. Revenues from professional fees increased $65.0
million, or 41%, to $223.2 million in 2000 from $158.2 million in 1999. The
increase in revenues is due to the combined effect of strong demand for our CRM
services and higher average billing rates in the period-over-period comparison.
Revenues from Managed Loyalty Services increased $5.9 million to $7.8
million in 2000 from $1.9 million in 1999. Managed Loyalty Services revenues
represented 3% and 1% of total revenues for the years ended December 30, 2000
and December 31, 1999, respectively. Revenues from software increased $2.4
million to $5.5 million in 2000 from $3.1 million in 1999. Revenues from
international operations decreased to approximately 12% of total revenues in
2000, compared to 17% in 1999.
Page 15
COST OF SERVICES
Cost of services increased $47.4 million, or 46%, to $150.7 million in
2000 from $103.3 million in 1999. This is due to an increase in the number of
our engageable consultants to 768 as of December 30, 2000, representing an
increase of 37%, from 561 at December 31, 1999. Cost of services as a percentage
of revenues increased to 64% in 2000 compared to 63% in 1999. This was due, in
part, to the approximately $5.9 million of incremental cost of services incurred
in 2000 as part of the expansion of our Managed Loyalty Services.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses increased $34.0 million,
or 86%, to $73.4 million in 2000 from $39.4 million in 1999. This increase is
the result of our growth and the build-out of our stand-alone infrastructure,
including finance, treasury, legal, human resources and technical systems
support, while also making payments to TSC for similar services as part of the
shared services agreement during the build-out process. The increase is also due
to the continued expansion of our business development group, establishment of
the eLoyalty brand in the marketplace and increased uncollectible amounts due
from clients, including a $2.8 million incremental charge in the fourth quarter
of 2000.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses increased $3.3 million, or 60%, to
$8.8 million in 2000 from $5.5 million in 1999. This increase is primarily due
to an increased investment in the Loyalty Lab, including the addition of
developers.
DEPRECIATION
Depreciation expense was $2.4 million for 2000 and $1.5 million in
1999. The increase was attributable to the implementation of IT infrastructure
which occurred in 2000, following the February 2000 spin-off from TSC.
GOODWILL AMORTIZATION
Goodwill amortization expense was $5.0 million for 2000 and 1999.
Goodwill amortization is primarily related to the acquisition of The Bentley
Group in 1997.
OTHER INCOME (EXPENSE)
We recognized non-operating other income of $2.9 million in 2000
compared to a non-operating other expense of $0.4 million in 1999. The $3.3
million increase in non-operating other income is primarily due to incremental
interest income earned as a result of higher average cash and cash equivalent
balances in 2000 versus 1999. The increase in the average cash balances was due
to the cash generated by financing activities, most of which were completed
during the first half of 2000.
INCOME TAX (BENEFIT) PROVISION
Income tax (benefit) provision represents combined federal, state and
foreign taxes. Due to a pre-tax loss of $0.8 million in 2000, a $0.4 million tax
benefit was recognized compared to $4.0 million tax provision recognized in
1999. The effective tax rate remained flat year-over-year.
NET (LOSS) INCOME
We reported a net loss of $0.4 million, or $0.09 per share on a diluted
basis, for 2000 as compared with net income of $4.1 million, or $0.92 per share
on a diluted basis, for 1999. The 2000 results are reflective of the $3.8
million operating loss for the year (as compared to operating income of $8.5
million in 1999), offset in substantial part by the non-operating interest
income from investment of increased cash balances obtained through financing
activities.
Page 16
LIQUIDITY AND CAPITAL RESOURCES
Our principal capital requirements are to fund working capital needs,
capital expenditures and other investments in support of revenue generation and
growth.
At December 29, 2001, we had cash and cash equivalents of $42.7 million
representing an increase of approximately $1.5 million in cash and cash
equivalents from December 30, 2000. Restricted cash represents cash as security
for our line of credit and letters of credit. The increase in our cash and cash
equivalents was primarily attributable to the $20.3 million cash generated from
financing activities, as described below. Both operating activities and
investing activities (in capital expenditures) negatively impacted our available
2001 cash resources, with a combined use of cash resources of approximately
$17.2 million.
Operating activities used net cash of approximately $8.7 million during
2001 compared to $22.3 million during 2000. In addition to the negative $63.7
million impact of its net loss in 2001, we also experienced a reduction in
accrued compensation due to the $90 million reduction in revenue and the
significant reduction in the work force. The reduction in accrued compensation
was also attributable to a decline in bonus accruals and the timing of salary
payments. Accounts receivable decreased by $47.7 million due to improved
invoicing and collection processes and systems. At December 29, 2001, there
remained $7.9 million of unpaid severance and related costs.
Cash flows used in investing activities consisted of capital
expenditures of $8.5 million during 2001, as compared to capital expenditures of
$18.6 million for 2000. The 2001 spending was primarily related to the
continuation of investments in computer hardware and software that were
completed in the US and established in non-US locations. The bulk of this system
implementation occurred in 2000 when we built out our own infrastructure as a
stand-alone company for US operations, following the February 2000 spin-off from
TSC. We expect that our capital expenditures for 2002 will be between $2 million
and $3 million.
We have made an additional commitment to invest up to $14.7 million,
through a related entity, in eLoyalty Ventures, L.L.C. ("eLoyalty Ventures").
eLoyalty Ventures is a $30 million venture capital fund formed in 2000 by
eLoyalty, together with entities associated with Bain Capital, Sutter Hill
Ventures and Technology Crossover Ventures, to focus on investing in early-stage
CRM technology companies. We have not been requested to contribute any of our
eLoyalty Ventures commitment and so remain subject to capital calls against that
commitment on 10 business days' prior written notice. While no formal action has
been taken to suspend the fund's activities, we believe none of the members of
eLoyalty Ventures would recommend investment activity at this time. We further
believe that the fund's management is not actively engaging in evaluation of
investment opportunities. Accordingly, we do not expect any expenditures
relating to this fund in 2002.
Cash flows provided by financing activities decreased $48.0 million to
$20.3 million for 2001 from $68.3 million in 2000. Cash from such activities
decreased during 2001 primarily as a result of two financing events in 2000: the
issuance of 4.5 million shares of eLoyalty's Common Stock to venture capital
investors for aggregate net proceeds of $34.9 million and a $20 million cash
contribution from TSC in connection with the spin-off. In 2001, we received
$23.3 million ($20.0 million, net) related to the issuance of the Series B
stock. Cash dividends of approximately $0.9 million are expected to be paid in
July 2002 on the Series B stock. In addition, two semi-annual dividend payments
of approximately $0.8 million each are expected to be paid in 2003 on the Series
B stock. The amount of the dividend would be affected by any conversions of the
Series B stock into common stock. We also received $8.6 million of financing
through our credit line and we deposited $9.4 million into a secured bank
account as a result of our Loan Agreement as discussed below. Additional cash
flows from financing activities were provided by cash proceeds of $1.1 million
from the exercise of employee stock options and purchases under our employee
stock purchase plan. We have elected to freeze the employee stock purchase plan
immediately following the next quarterly purchase at the end of the first
quarter 2002.
Page 17
Our near-term capital resources consist of our current cash balances,
together with anticipated future cash flows from operations and availability
under an external credit line. Our balance of cash and cash equivalents was
$42.7 million as of December 29, 2001.
We entered into a Loan Agreement with LaSalle Bank National Association
(the "Bank") effective as of December 17, 2001, providing for a secured
revolving line of credit in a maximum principal amount of $15 million through
December 28, 2002 (the "Facility"). The Facility requires us to maintain cash
and cash equivalents within a secured account at the Bank. The balance in this
secured account cannot be less than the total line of credit and letter of
credit obligations under the Facility. The Facility replaced our prior revolving
credit facility with Bank of America, N.A. At December 29, 2001, our borrowings
under the Facility equaled $8.6 million. Available credit under the Facility has
been reduced by an additional $0.8 million related to letters of credit issued
under the Facility for operational commitments. Loans under the Facility bear
interest at the Bank's prime rate or, at our election, an alternate rate of
LIBOR (London InterBank Offering Rate) plus 0.75%. Under the Facility, we agreed
to pay a commitment fee of $25,000.
At December 29, 2001 we had two customers, Telekom Austria and
UnitedHealth Group, which accounted for 20% and 18% respectively of our total
net accounts receivable. We have collected substantially all of these amounts.
With a higher percentage of our revenues dependent on fewer customers, delayed
payments by a few of our larger clients could result in additional borrowing
under the Facility. We currently have future minimum rental commitments under
non-cancellable operating leases of $16.6 million. These are due in the
following periods: $5.9 million in 2002, $9.7 million in 2003-2005, and $1.0
million in 2006-2007. Minimum payments have not been reduced by minimum sublease
rentals of $0.4 million, $0.3 million, $0.2 million and $0.2 million due in the
future for years 2002, 2003, 2004, and 2005, respectively, under noncancelable
subleases. Of the future minimum rental commitments, the Company has accrued as
part of the severance and related costs as discussed in Note Three, $2.5
million, $1.3 million, $0.6 million, $0.5 million and $0.6 million for 2002,
2003, 2004, 2005, 2006 and thereafter, respectively. These amounts are net of
estimated sublease recoveries.
We anticipate that our current cash resources, together with other
expected internal and external sources of liquidity, should be sufficient to
satisfy our working capital and capital expenditure needs for the balance of the
year. We also anticipate that our cash resources will be sufficient to meet our
long-term needs. If, however, our operating activities or net cash needs for the
year were to differ materially from current expectations due to uncertainties
surrounding the current capital market, credit and general economic conditions,
competition, potential for suspension or cancellation of a large project, there
could be no assurance that we would have access to additional external capital
resources on acceptable terms.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS
No. 141 requires that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001. SFAS No. 142 eliminates the
systematic amortization of goodwill and indefinite lived intangible assets and
requires them to be tested for impairment at least annually. Separable
intangible assets that are not deemed to have an indefinite life will continue
to be amortized over their useful lives. We adopted SFAS No. 141 effective July
1, 2001 and adopted SFAS No. 142 effective January 1, 2002. As total goodwill at
December 29, 2001 is $2.1 million, we do not expect that application of the
nonamortization and impairment provisions of SFAS No. 142 will have a material
impact on results of operations.
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations," which addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. SFAS No. 143 is required to be adopted for
fiscal years beginning after June 15, 2002. We do not expect the adoption of
SFAS No. 143 will have a material impact on our financial position and or
results of operations.
Page 18
In October 2001, the FASB issued SFAS No. 144, "Accounting for
Impairment or Disposal of Long-Lived Assets" which is effective for fiscal years
beginning after December 15, 2001. SFAS No. 144 addresses financial accounting
and reporting for the impairment or disposal of long-lived assets and supercedes
SFAS No. 121, "Accounting for Impairment of Long-Lived Assets and for Long Lived
Assets to be Disposed Of" while retaining many of the provisions of that
statement. We do not expect the adoption of SFAS No. 144 to have a material
impact on our financial position or results of operations.
In November 2001, the Emerging Issues Task Force ("EITF") reached a
consensus on "Income Statement Characterization of Reimbursements Received for
`Out-of-Pocket' Expenses Incurred." The EITF concluded that reimbursements
received for out-of-pocket expenses incurred should be characterized as revenue
in the income statement. This consensus is to be applied in financial reporting
periods beginning after December 15, 2001. We adopted this policy in this Form
10-K and have reclassed prior period amounts in order to make the financial
statements comparable. This change in presentation does not affect reported net
income or loss.
FACTORS THAT MAY AFFECT FUTURE RESULTS OR MARKET PRICE OF STOCK
Some of the factors that may affect our future results or the market
price of our stock and cause or contribute to material differences between
actual results and those reflected in forward-looking statements contained in
this Form 10-K include the following:
- uncertainties associated with the attraction of new clients,
the continuation of existing and new engagements with existing
clients and the timing of related client commitments, including
potential client delays or deferrals of new engagements or
existing project extensions in light of prevailing general
economic conditions and uncertainties;
- reliance on a relatively small number of customers for a
significant percentage of our revenues, reliance on major
suppliers, including CRM software providers and other alliance
partners, and maintenance of good relations with key business
partners;
- management of the risks associated with increasingly complex
client projects in general as well as new services offerings,
including risks relating to the variability and predictability
of the number, size, scope, cost and duration of, and revenues
from, client engagements, unanticipated cancellations or
deferrals of client projects or follow-on phases of engagements
in process, collection of billed amounts, shifts from time and
materials-based engagements to alternative pricing or
value-based models and variable employee utilization rates,
project personnel costs and project requirements;
- management of growth, expansion into new geographic and market
areas and development and introduction of new services
offerings, including the timely and cost-effective
implementation of enhanced operating, financial and other
infrastructure systems and procedures;
- challenges in attracting, training, motivating and retaining
highly skilled management, strategic, technical, product
development and other professional employees in a competitive
information technology labor market;
- continuing intense competition in the information technology
services industry generally and, in particular, among those
focusing on the provision of CRM services and software,
including firms with both significantly greater financial and
technical resources than eLoyalty and new entrants;
- the rapid pace of technological innovation in the information
technology services industry, including frequent technological
advances and new product introductions and enhancements, and
the ability to create innovative and adaptable solutions that
are consistent with evolving standards and responsive to client
needs, preferences and expectations;
- access in tightened capital and credit markets to sufficient
debt and/or equity capital on acceptable terms to meet our
future operating and financial needs;
- protection of our technology, proprietary information and
other intellectual property rights or challenges to our
intellectual property by third parties;
- future legislative or regulatory actions relating to the
information technology or information technology services
industries including those relating to data privacy;
- maintenance of our reputation and expansion of our name
recognition in the marketplace;
Page 19
- risks associated with global operations, including those
relating to the economic conditions in each country, potential
currency exchange and credit volatility, compliance with a
variety of foreign laws and regulations and management of a
geographically dispersed organization;
- the overall demand for CRM services and software and
information technology consulting services generally;
- the continued impact of the current economic slowdown, as well
as other future general business, capital market and economic
conditions and volatility; and
- significant revisions to current estimates of the timing and
amount of future taxable income during the carryforward period
may affect the realizability of deferred tax assets.
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
Our international operations create special risks, including those
relating to the economic conditions in each country, potential currency exchange
and credit volatility, restrictions on the movement of cash and certain
technologies across national borders, tax issues resulting from multiple tax
laws, compliance with a variety of other foreign national and local laws and
regulations, political instability and management of a geographically dispersed
organization. Our ability to deploy our resources globally while accommodating a
variety of local labor and immigration laws and regulations may become more
challenging as we implement our operational reorganization into global delivery
groups. If not adequately addressed, these risks may adversely affect our
business.
We provide solutions to clients in a number of countries including the
United States, Canada, United Kingdom, Germany, France and Australia. For the
years ended December 2001 and 2000, 23% and 17%, respectively, of our revenues
were denominated in foreign currencies. Historically, we have not experienced
material fluctuations in our results of operations due to foreign currency
exchange rate changes. As a result of our exposure to foreign currencies, future
financial results could be affected by factors such as changes in foreign
currency exchange rates or weak economic conditions in those foreign markets. We
do not currently engage nor is there any plan to engage in hedging foreign
currency risk.
We also have interest rate risk with respect to changes in variable
rate interest on our revolving line of credit. Interest on the line of credit is
based on LIBOR, which varies in accordance with prevailing market conditions. A
change in interest rate impacts the interest expense on the line of credit and
cash flows, but does not impact the fair value of the debt. A 1% increase in the
LIBOR rate would result in additional interest expense of approximately $0.1
million based on current borrowing.
Page 20
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS OF ELOYALTY CORPORATION
Financial Statements:
Page
Report of Independent Accountants 22
Consolidated Balance Sheets - December 29, 2001 and December 30, 2000 23
Consolidated Statements of Operations -- for each of the three years
in the period ended December 29, 2001 24
Consolidated Statements of Cash Flows - for each of the three
years in the period ended December 29, 2001 25
Consolidated Statements of Changes in Stockholders' Equity
(Accumulated Deficit) and Comprehensive Income (Loss) -- for
each of the three years in the period ended December 29, 2001 26
Notes to Consolidated Financial Statements 28
Financial Statement Schedule:
Schedule II-Valuation and Qualifying Accounts - for each of the
three years in the period ended December 29, 2001 48
Page 21
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of eLoyalty Corporation:
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, of cash flows, and of changes in
stockholders' equity (accumulated deficit) and comprehensive income (loss)
present fairly, in all material respects, the financial position of eLoyalty
Corporation and its subsidiaries (the "Company") at December 29, 2001 and
December 30, 2000, and the results of their operations and their cash flows for
the years ended December 29, 2001, December 30, 2000, and December 31, 1999 in
conformity with accounting principles generally accepted in the United States of
America. In addition, the accompanying financial statement schedule for the
years ended December 29, 2001, December 30, 2000 and December 31, 1999 presents
fairly, in all material respects, the information set forth therein when read in
conjunction with the related consolidated financial statements. These financial
statements and financial statement schedule are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements and financial statement schedule based on our audits. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States of America, which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Chicago, Illinois
January 31, 2002, except for Note 18, as to which the date is February 28, 2002
Page 22
ELOYALTY CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
December 29, December 30,
2001 2000
----------------- ---------------
ASSETS:
CURRENT ASSETS:
Cash and cash equivalents $ 42,653 $ 41,138
Restricted cash 9,448 --
Marketable securities -- 9,902
Receivables, net 22,934 75,886
Deferred income taxes 2,451 16,301
Prepaid expenses 1,190 2,935
Refundable income taxes 6,597 4,619
Other current assets 2,300 2,915
------------- -------------
Total current assets 87,573 153,696
Equipment and leasehold improvements, net 17,889 18,784
Goodwill, net 2,135 6,990
Deferred income taxes 20,059 2,664
Long-term receivables and other 358 2,484
------------- -------------
Total assets $ 128,014 $ 184,618
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY:
CURRENT LIABILITIES:
Short-term debt $ 8,600 $ --
Accounts payable 2,154 6,880
Accrued compensation and related costs 8,274 19,964
Deferred compensation -- 9,897
Other current liabilities 8,750 7,021
------------- -------------
Total current liabilities 27,778 43,762
------------- -------------
Long-term liabilities 3,390 --
Commitments and contingencies -- --
Redeemable Series B convertible preferred stock, $0.01 par value;
5,000,000 shares authorized and designated; 4,562,372 shares
issued and outstanding with a liquidation preference of
$23,318 at December 29, 2001 19,499 --
STOCKHOLDERS' EQUITY:
Preferred stock, $0.01 par value; 35,000,000 and 10,000,000 shares
authorized, respectively; none issued and outstanding -- --
Common stock, $0.01 par value; 50,000,000 and 100,000,000 shares authorized,
respectively; 5,629,218 and 49,925,702 shares
issued and outstanding, respectively 56 499
Additional paid-in capital 150,071 144,860
(Accumulated deficit) retained earnings (61,490) 2,171
Other (11,290) (6,674)
------------- -------------
Total stockholders' equity 77,347 140,856
------------- -------------
Total liabilities and stockholders' equity $ 128,014 $ 184,618
============= =============
The accompanying Notes to Consolidated Financial Statements are an integral part
of this financial information.
Page 23
ELOYALTY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
For the years ended December
----------------------------
2001 2000 1999
---- ---- ----
Revenues $ 146,729 $ 236,498 $ 163,180
Operating Expenses:
Cost of services 113,282 150,691 103,306
Selling, general and administrative 58,832 73,411 39,377
Severance and related costs 33,444 -- --
Research and development 5,091 8,821 5,494
Depreciation expense 5,683 2,372 1,502
Goodwill amortization 4,808 4,972 4,996
--------- --------- ---------
Total operating expenses 221,140 240,267 154,675
--------- --------- ---------
Operating (loss) income (74,411) (3,769) 8,505
Other income (expense) 1,654 2,921 (408)
--------- --------- ---------
(Loss) income before income taxes (72,757) (848) 8,097
Income tax (benefit) provision (9,096) (424) 4,039
--------- --------- ---------
Net (loss) income $ (63,661) $ (424) $ 4,058
Dividends and accretion related to Series B preferred
Stock (3,576) -- --
--------- --------- ---------
Net (loss) income available to common stockholders $ (67,237) $ (424) $ 4,058
========= ========= =========
Basic net (loss) income per common share $ (13.42) $ (0.09) $ 0.98
========= ========= =========
Diluted net (loss) income per common share $ (13.42) $ (0.09) $ 0.92
========= ========= =========
Shares used to calculate basic net (loss) income per
share 5,011 4,823 4,140
========= ========= =========
Shares used to calculate diluted net (loss) income per
share 5,011 4,823 4,420
========= ========= =========
Noncash compensation included in individual line items above:
Cost of services $ 841 $ 789 $ 319
Selling, general and administrative 2,294 1,337 251
Research and development 54 81 69
--------- --------- ---------
Total noncash compensation $ 3,189 $ 2,207 $ 639
========= ========= =========
The accompanying Notes to Consolidated Financial Statements are an integral part
of this financial information.
Page 24
ELOYALTY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
For the Years ended December
----------------------------
2001 2000 1999
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income $(63,661) $ (424) $ 4,058
Adjustments to reconcile net (loss) income to net cash used in operating
activities:
Depreciation, goodwill amortization and noncash compensation 13,680 9,551 7,137
Provision for uncollectible amounts 4,512 4,064 2,059
Severance and related costs, net of cash 14,436 -- --
Deferred income taxes (3,545) (7,950) (5,763)
Other -- -- 463
Changes in assets and liabilities:
Receivables 47,672 (36,932) (21,496)
Sales (purchases) of trading securities related to
deferred compensation program 9,902 (2,727) (2,689)
Other current assets (4,273) (8,407) (1,820)
Accounts payable (4,688) 6,281 (313)
Accrued compensation and related costs (13,318) 8,565 4,517
Deferred compensation (9,897) 2,722 2,689
Other current liabilities (1,621) 3,521 653
Other assets 2,125 (613) (536)
-------- -------- --------
Net cash used in operating activities (8,676) (22,349) (11,041)
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (8,542) (18,633) (2,175)
-------- -------- --------
Net cash used in investing activities (8,542) (18,633) (2,175)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of redeemable Series B
convertible preferred stock, net 19,988 -- --
Proceeds from revolving credit agreement 17,600 -- --
Repayments on revolving credit agreement (9,000) -- --
Required deposit on revolving credit agreement (9,448) -- --
Proceeds from stock compensation plans 1,130 8,552 --
Proceeds from issuance of common stock -- 34,914 --
Capital contribution from Technology Solutions Company -- 20,000 --
Net advances from Technology Solutions Company -- 4,802 21,929
-------- -------- --------
Net cash provided by financing activities 20,270 68,268 21,929
-------- -------- --------
Effect of exchange rate changes on cash and cash equivalents (1,537) 390 338
-------- -------- --------
Increase in cash and cash equivalents 1,515 27,676 9,051
Cash and cash equivalents, beginning of period 41,138 13,462 4,411
-------- -------- --------
Cash and cash equivalents, end of period $ 42,653 $ 41,138 $ 13,462
======== ======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid for interest $ 293 $ -- $ --
Cash (refunded) paid for income taxes $ (2,054) $ 9,865 $ --
The accompanying Notes to Consolidated Financial Statements are an integral part
of this financial information.
Page 25
ELOYALTY CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(ACCUMULATED DEFICIT) AND COMPREHENSIVE INCOME (LOSS)
(In thousands, except share data)
Accumulated
Advances Other
From Retained Comprehen-
Common Stock Additional Technology Earnings sive Total
----------------- Paid-in Solutions (Accumulated Income Unearned Stockholders'
Shares Amount Capital Company Deficit) (Loss) Compensation Equity
------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31,1998 -- $ -- $ -- $48,475 $ -- $ (587) $ -- $ 47,888
-----------------------------------------------------------------------------------------------------------------------------------
Net income 4,058 4,058
Foreign currency translation (260) (260)
-----
Comprehensive income 3,798
Net transfers from TSC 21,929 21,929
Issuance of
common stock 41,400,000 414 (414) --
Issuance of compensatory
stock options 963 (963) --
-----------------------------------------------------------------------------------------------------------------------------------
Balance,
December 31, 1999 41,400,000 414 963 74,048 -- (847) (963) 73,615
-----------------------------------------------------------------------------------------------------------------------------------
Net (loss) income (2,595) 2,171 (424)
Foreign currency translation (1,123) (1,123)
------
Comprehensive loss (1,547)
Net transfers and capital
contribution from TSC 24,802 24,802
Spin-off from Technology
Solutions Company 2,529,029 25 96,230 (96,255) --
Issuance of common stock
for stock option awards
and Employee Stock
Purchase Plan (ESPP) 1,163,568 12 8,540 8,552
Issuance of common stock
to venture capital firms 4,539,980 45 34,869 34,914
Issuance of compensatory
stock options 524 (524) --
Issuance of restricted common
stock pursuant to cancellation
of certain stock options 293,125 3 3,734 (3,737) --
Amortization of unearned
compensation 520 520
-----------------------------------------------------------------------------------------------------------------------------------
Balance,
December 30, 2000 49,925,702 $499 $144,860 $ -- $2,171 $(1,970) $(4,704) $140,856
-----------------------------------------------------------------------------------------------------------------------------------
Page 26
ELOYALTY CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS'
EQUITY (ACCUMULATED DEFICIT) AND COMPREHENSIVE INCOME (LOSS) (CONTINUED)
(In thousands, except share data)
Accumulated
Advances Other
From Retained Comprehen-
Common Stock Additional Technology Earnings sive Total
----------------- Paid-in Solutions (Accumulated Income Unearned Stockholders'
Shares Amount Capital Company Deficit) (Loss) Compensation Equity
------------------------------------------------------------------------------------------------------------------------------------
Balance,
December 30, 2000 49,925,702 $499 $144,860 $ -- $ 2,171 $(1,970) $(4,704) $140,856
-----------------------------------------------------------------------------------------------------------------------------------
Net loss (63,661) (63,661)
Foreign currency translation (2,571) (2,571)
------
Comprehensive loss (66,232)
Issuance of common stock
for stock option awards
and ESPP 638,785 6 1,124 1,130
Issuance of restricted and
installment common stock
pursuant to cancellation
of certain stock options
through an exchange 4,831,656 48 2,932 (2,980) --
Issuance of restricted
common stock 1,315,000 13 2,257 (2,270) --
Amortization/forfeitures of
unearned compensation (414,829) (4) (2,047) 3,205 1,154
Accretion of preferred
stock issuance costs (3,281) (3,281)
Preferred stock beneficial
conversion feature 4,015 4,015
Accretion of beneficial
conversion feature (245) (245)
Preferred stock dividend (50) (50)
Reverse 1:10 stock split (50,667,096) (506) 506 --
-----------------------------------------------------------------------------------------------------------------------------------
Balance,
December 29, 2001 5,629,218 $56 $150,071 $ -- $(61,490) $(4,541) $(6,749) $ 77,347
-----------------------------------------------------------------------------------------------------------------------------------
The accompanying Notes to Consolidated Financial Statements are an integral part
of this financial information.
Page 27
ELOYALTY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share data)
NOTE ONE--DESCRIPTION OF BUSINESS
eLoyalty is a global management consulting and systems integration
organization focused exclusively on building customer loyalty solutions for our
clients. eLoyalty offers a broad range of Customer Relationship Management
("CRM") related services including business strategy, technical architecture,
selecting, implementing and integrating appropriate CRM software applications
and providing ongoing support for multi-vendor systems.
eLoyalty was spun off from Technology Solutions Company ("TSC") into a
separate, publicly traded company on February 15, 2000 (the "spin-off"). The
spin-off, which was approved by the TSC Board of Directors on February 9, 2000,
was accomplished by distributing to TSC stockholders, as a dividend, all of the
outstanding common stock of eLoyalty owned by TSC. In the spin-off, TSC
stockholders received one share of eLoyalty common stock, par value $0.01 per
share, for every one share of TSC common stock they owned of record as of
February 9, 2000.
NOTE TWO--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation--The financial statements for periods subsequent
to the spin-off reflect eLoyalty's results of operations and financial position
as it operates as a separate, publicly traded company. The consolidated
financial statements for periods prior to the spin-off reflect eLoyalty's
results of operations and financial position as it operated within TSC, and have
been prepared using the historical basis in the assets, liabilities and results
of operations.
The consolidated statements of operations for the periods prior to
February 15, 2000 reflect all of the related costs of doing business including
an allocation of certain general corporate expenses of TSC not directly related
to eLoyalty's operations, including legal, information systems, finance,
insurance, human resources, benefits administration, stockholders' services and
corporate management services. These costs were allocated to eLoyalty primarily
on a proportional cost allocation method based on revenues and headcount.
Management believes these allocations were made on a reasonable basis.
The financial information for periods prior to February 15, 2000 may
not necessarily reflect what the financial position and results of operations of
eLoyalty would have been had eLoyalty operated as a separate, stand-alone
publicly traded entity during such periods.
Change in Fiscal Year-End--In connection with implementing new business
systems and processes in December 2000, eLoyalty changed from a calendar
year-end to a fiscal year ending with the Saturday closest to the end of
December. The fiscal year-end for 2001 is December 29 while the fiscal year-end
for 2000 is December 30 . Also, on November 22, 1998, TSC's Board of Directors
voted to change the fiscal year of TSC from a fiscal year ending on May 31 to a
calendar year ending on December 31 in each year.
Consolidation--The consolidated financial statements include the
accounts of eLoyalty and all of its subsidiaries. All significant intercompany
transactions have been eliminated.
Revenue Recognition--eLoyalty derives substantially all of its revenues
from professional services. eLoyalty provides professional services primarily on
a time and materials basis. Although eLoyalty occasionally performs projects on
a fixed fee basis, the total portion of revenues derived from fixed fee
engagements is not significant. eLoyalty recognizes revenues on the percentage
of completion method as services are performed, based on hourly billing rates.
Percentage of completion estimates are based on the ratio of actual hours
incurred to total estimated hours. From time to time, eLoyalty uses
subcontractors to supplement its resources in client engagements. Revenues
generated through subcontractors are recognized as the service is performed, and
the related subcontractor costs are included in cost of services as incurred.
Revenue reflects adoption of Financial Accounting Standards Board (FASB)
Emerging Issues Task Force (EITF) D-103 requiring billable expenses to be
reported as revenue. All periods presented have been revised to
Page 28
ELOYALTY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share data)
reflect this change. Losses on engagements, if any, are recognized when
determined. eLoyalty also derives revenues from in-house developed software and
in certain circumstances resale of third party software. Software license fee
revenues are recognized when persuasive evidence of an arrangement exists,
delivery has occurred, the license fee is fixed and determinable and the
collection of the fee is probable. Fees from licenses sold together with
consulting services are recognized upon delivery, provided that the above
criteria have been met and payment of the license fees is not dependent upon the
performance of the consulting services. In those instances when it is determined
that the payment of the license fee is dependent upon the performance of
consulting services, both the license and consulting fees are recognized under
the percentage of completion method of contract accounting. Revenues from
post-contract Loyalty Support(TM) are recognized ratably over the term of the
maintenance contract on a straight-line basis. Revenues from purpose-built
hosted solutions and e-PROFILE(TM) are recognized ratably over the contract
term.
Reclassifications--The accompanying consolidated financial statements
reflect reclassifications of billable expenses as part of FASB Emerging Issues
Task Force (EITF) D-103 requiring billable expenses to be reported as revenue.
It also reflects the reclassification of certain other costs of engageable
project personnel from Selling, General and Administrative to Cost of Services.
All periods presented have been revised to reflect these changes. These
reclassifications had no impact on net income (loss) or shareholders' equity.
Cost of Services--Cost of Services consist primarily of salaries,
incentive compensation, billable and non-billable expenses, employee benefits
for eLoyalty personnel available for client assignments, and fees paid to
subcontractors for work performed on client projects.
Cash and Cash Equivalents--eLoyalty considers all highly liquid
investments readily convertible into known amounts of cash (with original
maturities of three months or less) to be cash equivalents. These short-term
investments are carried at cost plus accrued interest, which approximates
market.
Restricted Cash--Restricted cash principally represents cash as
security for eLoyalty's line of credit and letters of credit.
Marketable Securities--eLoyalty's marketable securities consist of
investments related to eLoyalty's executive deferred compensation plan (see Note
Ten) and are classified as trading securities, with unrealized gains and losses
included in eLoyalty's statements of operations. Realized gains or losses are
determined based on the specific identification method. eLoyalty recognized a
net loss of $5 and $89 for the year ended December 29, 2001 and December 30,
2000, respectively, and a net gain of $730, for the year ended December 31,
1999. Since trading securities relate to eLoyalty's executive deferred
compensation plan, a corresponding adjustment is included in the statements of
operations to recognize eLoyalty's increased/decreased liability for the
deferred compensation plan. The executive deferred compensation plan was
terminated effective July 15, 2001 (see Note Ten).
Equipment and Leasehold Improvements--Computers, software, furniture
and equipment are carried at cost and depreciated on a straight-line basis over
their estimated useful lives. Leasehold improvements are amortized over the
lesser of the useful life or the lease term. Useful lives generally are five
years or less. Maintenance and repair costs are expensed as incurred. The cost
and related accumulated depreciation of assets sold or disposed of are
eliminated from the respective accounts and resulting gain or loss is included
in the statements of operations. The carrying value of equipment and leasehold
improvements is periodically reviewed to assess recoverability based on future
undiscounted cash flows. An impairment loss, if any, would be measured as the
excess of the carrying value over the fair value.
eLoyalty accounts for software developed for internal use in accordance
with Statement of Position 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use." As such, costs incurred that relate to
the planning and post-implementation phases of development are expensed. Costs
incurred to develop internal use software are capitalized and amortized over the
asset's estimated useful life, generally three to five years.
Page 29
ELOYALTY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share data)
Goodwill--Goodwill is amortized on a straight-line basis, generally
over a five-year period. Accumulated amortization of goodwill as of December 29,
2001 and December 30, 2000 was $20,043 and $16,477, respectively. The carrying
value of goodwill is periodically reviewed to assess recoverability based on
future undiscounted cash flows. An impairment loss, if any, would be measured as
the excess of the carrying value over the fair value. In June 2001, the FASB
issued Statement of Financial Accounting Standards ("SFAS") No. 142 "Goodwill
and Other Intangible Assets" which requires that goodwill no longer be amortized
effective January 2002. In association with this, the net book value of this
asset will be periodically reviewed to assess recoverability based on future
discounted cash flows. At December 29, 2001, unamortized goodwill aggregated
$2.1 million.
Research and Development Costs--Research and development costs are
expensed as incurred. Research and development expenses relate primarily to the
dedicated research and development facility maintained by eLoyalty, and consist
primarily of salaries, incentive compensation and employee benefits costs for
dedicated personnel, occupancy costs, staff recruiting costs, administrative
costs, travel expenses and depreciation.
Software Development Costs--eLoyalty capitalizes software development
costs for software to be sold to third parties once technological feasibility is
established and prior to general release. Amortization is computed as the
greater of the amount computed using the (a) ratio of current revenues to the
total current and anticipated future revenues or (b) the straight-line method
over the estimated economic life of the product. There are no capitalized
software development costs included on eLoyalty's balance sheets as of December
29, 2001 or December 30, 2000.
Stockholders' Equity--Stockholders' equity includes common stock
issued, additional paid-in capital, retained earnings (deficit), accumulated
other comprehensive income (loss) related to foreign currency translation and
unearned compensation related to stock-based compensation. Net transfers from
TSC represent transfers to eLoyalty primarily for operations and working capital
requirements, offset by cash collected by TSC for the periods prior to the
spin-off. In connection with the spin-off, net transfers from TSC were recorded
as common stock and additional paid-in capital (see Note Four). Following the
spin-off, eLoyalty no longer received operational funding from TSC and no longer
participated in the TSC cash management program. The 4.6 million shares issued
of redeemable 7% Series B Convertible Preferred Stock is not classified as
permanent equity in the accompanying balance sheets as the preferred
stockholders' have the ability to trigger a redemption that is considered
outside eLoyalty's control.
Earnings (Loss) Per Common Share--eLoyalty calculates earnings (loss)
per share in accordance with SFAS No. 128, "Earnings per Share." Basic earnings
per share have been computed by dividing the net earnings for each period
presented by the weighted average shares outstanding. Diluted earnings per share
have been computed by dividing the net earnings by the weighted average shares
outstanding plus the dilutive effect of common stock equivalents using the
"treasury stock" method. In periods in which there was a loss, the dilutive
effect of common stock equivalents was not included in the dilutive earnings per
share calculation as they were antidilutive.
Foreign Currency Translation--The functional currencies for eLoyalty's
foreign subsidiaries are their local currencies. All assets and liabilities of
foreign subsidiaries are translated to US dollars at end of period exchange
rates. The resulting translation adjustments are recorded as a component of
stockholders' equity and comprehensive income. Income and expense items are
translated at average exchange rates prevailing during the period. Gains and
losses from foreign currency transactions of these subsidiaries are included in
the consolidated statements of operations.
Fair Value of Financial Instruments--The carrying values of current
assets and liabilities approximated their fair values as of December 29, 2001
and December 30, 2000.
Concentration of Credit Risk--Financial instruments that potentially
subject eLoyalty to a concentration of credit risk consists of cash and cash
equivalents, restricted cash and accounts receivable. Cash and cash equivalents
and restricted cash are deposited with high credit quality financial
institutions. The Company's accounts receivable are derived from revenue earned
from customers located primarily in the US and are denominated in US dollars.
For the year
Page 30
ELOYALTY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share data)
ended December 29, 2001, eLoyalty had two clients, each accounting for 13% of
eLoyalty's total revenue: Agilent Technologies and UnitedHealth Group. In June
2001, Agilent Technologies notified eLoyalty of the cancellation of the project
on which eLoyalty and other third parties were engaged. Agilent Technologies
also accounted for 15% of revenues for the year ended December 30, 2000. No
client accounted for 10% or more of revenues during the year ended December 31,
1999. At December 29, 2001, we had two customers, Telekom Austria and
UnitedHealth Group, which accounted for 20% and 18% respectively of our total
net accounts receivable. We have collected substantially all of these amounts.
Stock-Based Compensation--eLoyalty accounts for stock-based
compensation using the intrinsic value method prescribed in Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees," and related interpretations. Compensation costs for employee stock
options are measured as the excess, if any, of the fair value of common stock at
the date of grant over the amount an employee must pay to acquire the stock,
providing that all other requirements for fixed plan accounting are satisfied.
In the event stock options are granted at a price lower than the fair value on
the date of grant, the difference is recorded as unearned compensation.
Cancelled and reissued stock options are accounted for under variable plan
accounting with the related unearned compensation subject to adjustment in
future periods based on the fluctuations of the fair value of the common stock.
Unearned compensation is amortized over the vesting period of the related stock
option or right. The unearned compensation recorded at December 29, 2001,
December 30, 2000 and December 31, 1999 relates solely to eLoyalty stock-based
awards.
Income Taxes--eLoyalty uses an asset and liability approach, as
required under SFAS No. 109, to financial accounting and reporting for income
taxes. Deferred income taxes are provided when tax laws and financial accounting
standards differ with respect to the amount of income for a year and the basis
of assets and liabilities and for tax loss carryforwards. eLoyalty does not
provide US deferred income taxes on earnings of foreign subsidiaries which are
expected to be indefinitely reinvested. Prior to the spin-off, eLoyalty's
results have been included in TSC's consolidated federal and state income tax
returns. The income tax provision for such periods is calculated, and deferred
tax assets and liabilities are recorded, as if eLoyalty had operated as an
independent entity.
Use of Estimates--The preparation of the financial statements in
conformity with accounting principles generally accepted in the United States
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those amounts.
New Accounting Standards--In June 2001, the FASB issued SFAS No. 141,
"Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 141 requires that the purchase method of accounting be used
for all business combinations initiated after June 30, 2001. SFAS No. 142
eliminates the systematic amortization of goodwill and indefinite lived
intangible assets and requires them to be tested for impairment at least
annually. Separable intangible assets that are not deemed to have an indefinite
life will continue to be amortized over their useful lives. eLoyalty adopted
SFAS No. 141 effective July 1, 2001 and adopted SFAS No. 142 effective January
1, 2002. As total goodwill at December 29, 2001 is $2.1 million, we do not
expect that application of the nonamortization and impairment provisions of SFAS
No. 142 will have a material impact on results of operations, cash flows or
financial position.
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations," which addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. SFAS No. 143 is required to be adopted for
fiscal years beginning after June 15, 2002. eLoyalty does not expect the
adoption of SFAS No. 143 will have a material impact on eLoyalty's financial
position or results of operations.
In October 2001, the FASB issued SFAS No. 144, "Accounting for
Impairment or Disposal of Long-Lived Assets" which is effective for fiscal years
beginning after December 15, 2001. SFAS No. 144 addresses financial
Page 31
ELOYALTY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share data)
accounting and reporting for the impairment or disposal of long-lived assets and
supercedes SFAS No. 121, "Accounting for Impairment of Long-Lived Assets and for
Long Lived Assets to be Disposed Of" while retaining many of the provisions of
that statement. eLoyalty does not expect the adoption of SFAS No. 144 to have a
material impact on eLoyalty's financial position or results of operations.
In November 2001, the Emerging Issues Task Force ("EITF") reached a
consensus on "Income Statement Characterization of Reimbursements Received for
`Out-of-Pocket' Expenses Incurred." The EITF concluded that reimbursements
received for out-of-pocket expenses incurred should be characterized as revenue
in the income statement. This consensus is to be applied in financial reporting
periods beginning after December 15, 2001. We adopted this policy in this Form
10-K and have reclassed prior period amounts in order to make the financial
statements comparable. This change in presentation does not affect reported net
income or loss.
NOTE THREE--SEVERANCE AND RELATED COSTS
During 2001, eLoyalty recognized pre-tax charges of $11.4 million,
$10.7 million, $7.1 million, and $4.2 million in first quarter, second quarter,
third quarter, and fourth quarter, respectively. This aggregate $33.4 million
charge for 2001 was the result of cost reduction actions taken throughout the
year. These charges relate to employee severance payments and related costs for
the elimination of approximately 475 positions, in both the North American and
International segment, and related office closures. Severance costs include
contractual salary and related fringe benefits over the severance payment
period, forgiveness of employee loans and outplacement costs. Facility costs
primarily include expected losses on contractual lease commitments, net of
estimated sublease recoveries, and write down of leasehold improvements. Other
costs include laptop and other computer lease termination costs, legal expenses
and the write down of deposits related to outside services, which have been
terminated.
During the twelve months ended December 29, 2001, eLoyalty made cash
payments of $19.0 million. Annual savings resulting from these actions are
expected to be about $65 million and will substantially be realized in 2002. A
portion of these savings were recognized in 2001. eLoyalty expects substantially
all severance and related costs to be paid out by the end of 2002 pursuant to
agreements entered into with affected employees, facility costs related to the
office closures to be paid pursuant to contractual lease terms through 2007 and
other costs to be paid pursuant to contractual commitments through 2003.
The severance and related costs and their utilization as of and for the
year ended December 29, 2001 are as follows:
Reserve
Utilized Balance
2001 through December 29,
Charges 12/29/01 2001
--------------------------------------------------------------------------------------------------------------
Employee severance $ 20,218 $ 18,617 $ 1,601
Facilities 8,076 3,935 4,141
Other 5,150 2,976 2,174
--------------------------------------------------------------------------------------------------------------
Total $ 33,444 $ 25,528 $ 7,916
--------------------------------------------------------------------------------------------------------------
Of the $7,916 that remains reserved as of December 29, 2001, $3,390
related to future lease payments net of estimated sublease recoveries is
reflected in Long Term Liabilities, $1,601 related to severance payments is
reflected in Accrued Compensation and the balance of $2,925 is reflected in
Other Current Liabilities.
In addition eLoyalty expects an estimated $1 million to $2 million
pre-tax charge to be taken in the first quarter of 2002, relating primarily to
severance benefits associated with further anticipated reductions in headcount.
These additional severance benefits are expected to be substantially paid out by
the end of 2002.
Page 32
ELOYALTY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share data)
NOTE FOUR--ELOYALTY SPIN-OFF FROM TECHNOLOGY SOLUTIONS COMPANY
eLoyalty was spun off from TSC into a separate, publicly traded company
on February 15, 2000. In connection with the spin-off, TSC's net advances to
eLoyalty were recorded as common stock and additional paid-in capital. The net
assets distributed to eLoyalty were as follows:
February 15, 2000
-------------------------------------------------------------------------------
Cash $ 30,794
Receivables, net 50,056
Other current assets 23,603
Goodwill 11,342
Other long-term assets 7,379
Accounts payable 1,238
Other current liabilities 26,784
NOTE FIVE--RELATED PARTY TRANSACTIONS
Pursuant to the spin-off, on February 15, 2000, eLoyalty entered into
contractual arrangements with TSC whereby TSC provided eLoyalty with certain
administrative support through 2000. The total charges from TSC for the years
ended December 30, 2000 and December 31, 1999 were $5,036, and $14,173,
respectively.
eLoyalty periodically provides employee loans as part of employment
agreements. These loans have interest rates ranging from 2.5% to 6.6%. The loans
are generally forgiven over one to three years at various rates, depending on
the value of the loan and the terms of the employment agreement, based on
continued employment with eLoyalty. The unforgiven loan balances and related
accrued interest are due and payable in full if an employee terminates
employment before the end of the loan term. The total value of outstanding
employee loans, including certain loans to officers, was $1.1 million and $3.4
million, respectively, as of December 29, 2001 and December 30, 2000.
NOTE SIX--RECEIVABLES, NET
Receivables consist of the following:
As of December
2001 2000
-----------------------------------------------------------------------------------------
Amounts billed to clients $ 25,210 $ 62,501
Unbilled revenues 124 14,990
----------------------------------------------------------------------------------------
25,334 77,491
Reserve for uncollectible amounts (2,400) (1,605)
----------------------------------------------------------------------------------------
Receivables, net $22,934 $75,886
----------------------------------------------------------------------------------------
Amounts billed to clients represent professional fees and reimbursable
project-related expenses. Unbilled revenues represent professional fees,
project-related expenses, materials and subcontractor costs performed in advance
of billings in accordance with contract terms. A substantial portion of unbilled
revenues at the end of any period are billed in the following period. Unbilled
revenues at December 29, 2001 and December 30, 2000 consist of amounts due from
customers to be collected within one year of the balance sheet date.
Page 33
ELOYALTY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share data)
NOTE SEVEN--EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment and leasehold improvements consist of the following:
As of December
----------------------
2001 2000
----------------------------------------------------------------------------------------
Computers and software $21,195 $15,840
Furniture and equipment 4,117 4,750
Leasehold improvements 1,486 3,338
----------------------------------------------------------------------------------------
26,798 23,928
Accumulated depreciation and amortization (8,909) (5,144)
----------------------------------------------------------------------------------------
Equipment and leasehold improvements, net $17,889 $18,784
----------------------------------------------------------------------------------------
Depreciation expense was $5,683, $2,372, and $1,502 for the years ended
December 29, 2001, December 30, 2000 and December 31, 1999, respectively.
NOTE EIGHT--INCOME TAXES
The income tax (benefit) provision consists of the following:
For the Years Ended
------------------------------------------------
December 29, December 30, December 31,
2001 2000 1999
--------------------------------------------------------------------------------------------------------------
Current:
Federal $ (5,465) $ 6,950 $ 4,546
State (208) 859 1,059
Foreign 122 (712) 1,876
--------------------------------------------------------------------------------------------------------------
Total current (5,551) 7,097 7,481
--------------------------------------------------------------------------------------------------------------
Deferred:
Federal (12,709) (1,923) (2,008)
State (1,633) 204 (478)
Foreign 10,797 (5,802) (956)
--------------------------------------------------------------------------------------------------------------
Total deferred (3,545) (7,521) (3,442)
--------------------------------------------------------------------------------------------------------------
Income tax (benefit) provision $ (9,096) $ (424) $ 4,039
--------------------------------------------------------------------------------------------------------------
Page 34
ELOYALTY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share data)
Total income tax (benefit) provision differed from the amount computed by
applying the federal statutory income tax rate due to the following:
For the Years Ended
-----------------------------------------------
December 29, December 30, December 31,
2001 2000 1999
---------------------------------------------------------------------------------------------------------------
Federal tax provision
(benefit), at statutory rate $(25,465) $(297) $2,834
State tax provision (benefit),
net of federal benefit (2,510) 539 405
Effect of foreign tax rate
differences 96 (1,205) 406
Nondeductible expenses 202 208 134
Nondeductible goodwill 263 235 279
Other 1,527 96 (19)
Non US rate changes 1,290 -- --
Non US NOL Adjustments 1,421 -- --
Non US deferred valuation allowance 14,080 -- --
--------------------------------------------------------------------------------------------------------------
Income tax (benefit) provision $ (9,096) $(424) $4,039
--------------------------------------------------------------------------------------------------------------
Deferred tax assets and liabilities were comprised of the following:
As of December
-------------------
2001 2000
--------------------------------------------------------------------------------------
Deferred tax assets:
Deferred compensation and bonuses $ -- $ 3,753
Equity losses of unconsolidated investee 400 341
Receivable allowances 672 448
Other accruals 1,460 2,061
Net operating loss carryforwards 29,787 10,798
Depreciation and amortization 1,364 2,680
Non-deductible reserves 2,468 --
Tax credit carry forwards 520 --
Non US deferred valuation allowance (14,080) --
--------------------------------------------------------------------------------------
Total deferred tax assets 22,591 20,081
--------------------------------------------------------------------------------------
Deferred tax liabilities:
Prepaid expenses (81) (1,116)
--------------------------------------------------------------------------------------
Total deferred tax liabilities (81) (1,116)
--------------------------------------------------------------------------------------
Net deferred tax asset $ 22,510 $18,965
--------------------------------------------------------------------------------------
We have recorded a deferred tax asset of $22,510 reflecting primarily
the benefit of US loss carryforwards, which expire in periods through 2021.
Realization is dependent on generating sufficient taxable income in the US prior
to expiration of these loss carryforwards. Although realization is not assured,
we believe that it is more likely than not that all of the deferred tax asset
will be realized. The amount of the deferred tax asset considered realizable,
however, could be reduced in the near term if current estimates of the timing
and amount of future taxable income during the carryforward period are
significantly revised.
During the second quarter of 2001, we established a valuation allowance
against the benefit of certain international operating unit tax losses
previously recognized and ceased recognizing the benefit of losses incurred by
these operating
Page 35
ELOYALTY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share data)
units. This decision was made following a company-wide review of expected
financial results by geography under various alternative scenarios and the
related assessments of recoverability of these net deferred tax assets in light
of the period over which they arose and the predictability of a near-term return
of international operating units to acceptable, continuing levels of
profitability. As of December 29, 2001, we had a valuation allowance of $14,080
relating to these international operating unit tax losses.
Pursuant to the Tax Sharing and Disaffiliation Agreement between TSC
and eLoyalty, TSC will generally be liable to eLoyalty for any income tax
benefits realized by TSC related to the exercise of eLoyalty stock options by
TSC employees (see Note Thirteen). With respect to the realizability of these
tax benefits, if any, eLoyalty is dependent on TSC's ability to realize the
benefits, and accordingly, eLoyalty does not recognize these benefits until
realized by TSC.
Income (loss) before income taxes consisted of the following:
For the Years Ended
-----------------------------------------------------
December 29, December 30, December 31,
2001 2000 1999
-------------------------------------------------------------------------------------------------------------------
United States $(50,203) $18,602 $7,447
Foreign (22,554) (19,450) 650
-------------------------------------------------------------------------------------------------------------------
Total $(72,757) $ (848) $8,097
-------------------------------------------------------------------------------------------------------------------
eLoyalty's ability to utilize its net operating loss (NOL)
carryforwards could become subject to significant limitations under Section 382
of the Internal Revenue Code if eLoyalty were to undergo an ownership change. An
ownership change would occur if the stockholders who own or have owned, directly
or indirectly, 5% or more of eLoyalty's common stock or are otherwise treated as
5% stockholders under Section 382 and the regulations promulgated thereunder
increase their aggregate percentage ownership of eLoyalty's stock by more than
50 percentage points over the lowest percentage of the stock owned by these
stockholders at any time during the testing period, which is generally the
three-year period preceding the potential ownership change. In the event of an
ownership change, Section 382 imposes an annual limitation on the amount of
taxable income a corporation may offset with NOL carryforwards. Any unused
annual limitation may be carried over to later years until the applicable
expiration date for the respective NOL carryforwards.
NOTE NINE--LINE OF CREDIT
eLoyalty entered into a Loan Agreement with LaSalle Bank National
Association (the "Bank") effective as of December 17, 2001, providing for a
secured revolving line of credit in a maximum principal amount of $15 million
through December 28, 2002 (the "Facility"). The Facility requires eLoyalty to
maintain a minimum cash and cash equivalent balance within a secured account at
the Bank. The balance in the secured account cannot be less than the outstanding
balance drawn on the line of credit and all outstanding letter of credit
obligations under the Facility. The Facility replaced eLoyalty's prior revolving
credit facility with the Bank of America, N.A. eLoyalty's borrowings under the
Facility aggregated $8,600 at December 29, 2001. Available credit under the
Facility has been reduced by an additional $848 related to letters of credit
issued under the Facility for operational commitments. Loans under the Facility
bear interest at the Bank's prime rate or, at eLoyalty's election, an alternate
rate of LIBOR (London InterBank Offering Rate) plus 0.75%. The effective annual
interest rate at December 29, 2001 was 2.67% under the Facility.
NOTE TEN--EXECUTIVE DEFERRED COMPENSATION PLAN
We terminated our Executive Deferred Compensation Plan effective July
15, 2001, and provided for all participant account balances to be distributed in
a lump sum following the termination effective date. We also terminated an
associated Executive Benefit Trust, effective on completion of distributions
from the plan. This nonqualified deferred
Page 36
ELOYALTY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share data)
compensation plan allowed eligible participants (employees at or above the level
of Vice President) to defer receipt of a portion of their cash compensation. All
distributions from this plan were completed before September 29, 2001.
Investments purchased by eLoyalty with the deferred compensation funds and the
corresponding obligations to participants, including investment earnings
thereon, are reflected as assets and liabilities, respectively, on our balance
sheet as of December 30, 2000 under the captions "Marketable Securities" and
"Deferred Compensation". Prior to the spin-off from TSC, eLoyalty executives
participated in the TSC non-qualified executive deferred compensation plan.
NOTE ELEVEN--EMPLOYEE BENEFIT PLANS
eLoyalty Corporation 401(k) Plan--eLoyalty employees are eligible to
participate in the eLoyalty Corporation 401(k) Plan (the "401(k) Plan") on the
first day of the month coinciding with or following their date of hire. The
401(k) Plan allows employees to contribute up to 15% of their annual
compensation, subject to Internal Revenue Service statutory limits. Company
contributions are made annually to the 401(k) Plan at the discretion of the
Board of Directors. Company contributions were made annually for 2001 and prior
years. Effective in 2002, the matching contribution will no longer be
discretionary. Instead, the Board of Directors approved a non-discretionary
matching contribution at the rate of 50% of the first 6% of eligible
compensation contributed to the 401(k) Plan with a maximum match of 3% of
eligible earnings. Prior to the spin-off from TSC, eLoyalty employees
participated in the TSC 401(k) Plan. eLoyalty recognized expenses related to
these 401(k) plans of $540, $1,697 and $1,131 for the years ended December 29,
2001, December 30, 2000 and December 31, 1999, respectively.
eLoyalty Employee Stock Purchase Plan--eLoyalty employees are eligible
to participate in the eLoyalty employee stock purchase plan (the "Stock Purchase
Plan") after meeting certain minimum eligibility service requirements. The Stock
Purchase Plan qualifies under section 423 of the Internal Revenue Code ("IRC")
and is administered by the Compensation Committee of the Board of Directors. The
Stock Purchase Plan permits eligible employees to purchase an aggregate of
125,000 shares of eLoyalty's common stock. Shares are purchased by the plan for
the benefit of the participants at the end of each three-month purchase period.
The Stock Purchase Plan purchased 55,800 shares of eLoyalty common stock for the
year ended December 29, 2001. The Company has elected to freeze the Stock
Purchase Plan immediately following the next quarterly purchase at the end of
the first quarter 2002, previously due to low employee participation. eLoyalty
retains the ability to reactivate this plan in the future.
NOTE TWELVE--REDEEMABLE CONVERTIBLE PREFERRED STOCK AND CAPITAL STOCK
On December 18, 2001, eLoyalty's stockholders approved, at a special
meeting (i) the issuance and sale of shares of redeemable 7% Series B
Convertible Preferred Stock (the "Series B stock") in a private placement
financing; (ii) an increase in the number of authorized shares of eLoyalty's
Common Stock and preferred stock in connection with the private placement and
rights offering described below; and (iii) a one-for-ten reverse split of
eLoyalty's outstanding Common Stock and a corresponding reduction in the number
of authorized shares of common stock described below.
The private placement involved the sale of approximately 3.2 million
shares of Series B stock to various funds managed by Technology Crossover
Ventures ("TCV") and Sutter Hill Ventures ("Sutter Hill"), for gross proceeds of
approximately $16,000. The purchase price per share of Series B stock was $5.10
(after giving effect to the one-for-ten reverse stock split, which was effected
immediately prior to the closing of the transaction). The private placement was
completed on December 19, 2001, concurrently with the rights offering described
below.
In connection with the private placement, eLoyalty conducted a rights
offering in which existing common stockholders on the record date for the rights
offering, October 8, 2001, were offered the right to purchase Series B stock at
the same price as the investors in the private placement. Pursuant to the rights
offering, on December 19, 2001, eLoyalty sold approximately 1.4 million shares
of Series B stock for gross proceeds of approximately $7,300.
Page 37
ELOYALTY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share data)
At the time of issuance of the Series B stock, a beneficial conversion
adjustment was calculated (since the fair market value of a share of common
stock at the time exceeded the purchase price of a share of Series B stock)
aggregating $4.0 million. The Series B stock was recorded at the date of
issuance net of issuance costs and the beneficial conversion adjustment. The
discount attributable to the issuance costs was fully accreted on the date of
issuance by charging additional paid-in capital and increasing the recorded
amount of Series B stock. The Series B stock will be accreted to its full
redemption value of $23,300 on a straight line basis from the date of issuance
to June 19, 2002 by charging additional paid-in capital of $669 per month and
increasing the recorded amount of Series B stock by a like amount.
The Series B stock accrues dividends at a rate of 7% per annum, is
entitled to a preference upon liquidation and is convertible on a one for one
basis into shares of our common stock beginning on June 19, 2002, subject to
adjustment for stock splits, stock dividends and similar actions. The Series B
stock generally votes on a one for one basis with the common stockholders,
subject to adjustment for certain actions and specified matters as to which the
Series B stock is entitled to a separate class vote.
On December 19, 2001, prior to the closing of the private placement and
rights offering, eLoyalty amended its Certificate of Incorporation to increase
the authorized number of shares of its common stock from 100 million shares to
500 million shares (which was subsequently reduced to 50 million shares in
connection with the reverse stock split) and in the authorized number of shares
of its preferred stock from 10 million shares to 40 million shares. In
connection with this, eLoyalty increased the number of authorized shares of
Series A junior participating preferred stock designated in connection with its
Rights Plan (described below) from 1 million to 5 million shares, which are
included in the 40 million shares of preferred stock described above.
Also on December 19, 2001, immediately prior to the closing of the
private placement and rights offering but after the increase in authorized share
capital described above, eLoyalty effected a one-for-ten reverse split of its
issued and outstanding common stock, with a corresponding reduction in the
number of authorized shares of common stock. eLoyalty effected the reverse stock
split (1) to reduce the number of its shares outstanding after the private
placement and the rights offering to allow it to rationalize its resulting
equity capital structure, (2) to enhance the acceptability and marketability of
its common stock to the financial community and the investing public, and (3) to
attempt to increase the per share market price of its common stock above
Nasdaq's $1.00 minimum bid requirement.
eLoyalty was spun off from TSC into a separate, publicly traded company
on February 15, 2000. In connection with establishing eLoyalty as a separate
entity, 100 million shares (pre-split) of common stock, $0.01 par value, were
authorized, of which 43,929,029 common stock shares (pre-split) were issued.
Pursuant to the spin-off, eLoyalty received $8,400 from the sale of 2.5
million shares (pre-split) of common stock to TCV and Sutter Hill. On May 26,
2000, eLoyalty also closed its common stock purchase agreement with TCV entities
and issued 2 million shares (pre-split) of common stock at $13.50 per share, the
closing market price on April 18, 2000, the signing date of the initial letter
of intent, for proceeds of $26,500, net of issuance costs.
On March 17, 2000, the Board of Directors adopted a Stockholder Rights
Plan (the "Rights Plan"). The Rights Plan is intended to assure fair and equal
treatment for all of eLoyalty's stockholders in the event of a hostile takeover
attempt.
Under the terms of the Rights Plan, after giving effect to the reverse
stock split described above, each share of eLoyalty's common stock has
associated with it ten rights ("Rights"). Each Right entitles the registered
holder to purchase from eLoyalty one one-hundredth of a share of Series A junior
participating preferred stock, without par value, at an exercise price of $160
(subject to adjustment). The Rights become exercisable under certain
circumstances: 10 days after the first public announcement that any person (an
"acquiring person") has acquired 15% or more of eLoyalty's common stock or the
announcement that any person has commenced a tender offer for 15% or more of
eLoyalty's common stock. On September 24, 2001, eLoyalty amended the Rights Plan
in connection with the private placement
Page 38
ELOYALTY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share data)
described above. The amendment provides, among other things, that (i) TCV and
certain related parties shall not become an "acquiring person" for purposes of
the Rights Plan so long as they do not own more than 35% of eLoyalty's
outstanding common stock (determined after giving effect to the conversion of
the new Series B stock), and (ii) Sutter Hill and certain related parties shall
not become an "acquiring person" for purposes of the Rights Plan so long as they
do not own more than 20% of eLoyalty's outstanding common stock (determined
after giving effect to the conversion of the new Series B preferred stock).
In general, eLoyalty may redeem the Rights in whole, but not in part,
at a price of $0.01 per Right at any time until 10 days after any person has
acquired 15% or more of eLoyalty's common stock. The Rights will expire on March
17, 2010, unless earlier redeemed by eLoyalty or exchanged for other shares of
eLoyalty's common stock.
Under specified conditions, each Right will entitle the holder to
purchase eLoyalty's common stock (or if eLoyalty is acquired in a merger or
other business combination, common stock of the acquiror) at the exercise price
having a current market value of two times the exercise price. The terms of the
Rights may be amended by eLoyalty's Board of Directors.
NOTE THIRTEEN--STOCK INCENTIVE PLANS
eLoyalty maintains two stock incentive plans: the eLoyalty Corporation
1999 Stock Incentive Plan (the "1999 Plan") and the eLoyalty Corporation 2000
Stock Incentive Plan (the "2000 Plan"). All share amounts in this Note Thirteen
are presented after giving effect to the one-for-ten reverse stock split
described in Note Twelve, unless indicated otherwise.
Under the 1999 Plan, awards of stock options, stock appreciation
rights, bonus and restricted stock and performance shares may be granted to
directors, officers, employees, consultants, independent contractors and agents
of eLoyalty and its subsidiaries. Stock option awards may be in the form of
incentive or non-statutory options, provided that incentive stock options may
only be granted to officers and employees of eLoyalty. All awards made under the
1999 Plan to date have been in the form of non-statutory stock options,
restricted stock or bonus (installment) stock. An aggregate of 534,000 shares of
eLoyalty common stock was initially reserved for issuance under the 1999 Plan
for all awards other than those issued in connection with the spin-off as
discussed below. On the first day of each fiscal year, beginning in 2000, the
aggregate number of shares available for issuance under the 1999 Plan is
automatically increased by an amount equal to 5% of the total number of shares
of common stock that are outstanding as of the time of the increase. In
addition, 738,756 shares were reserved for issuance under the 1999 Plan in
connection with the spin-off in substitution of previously granted options to
purchase shares of TSC common stock. These substitute options are not subject to
the limit on shares reserved set forth above.
On May 12, 2000, the Board of Directors approved the eLoyalty
Corporation 2000 Stock Incentive Plan. Under the original terms of the 2000
Plan, non-statutory stock option awards may be granted to officers, employees
and certain consultants and independent contractors of eLoyalty and its
subsidiaries. The 2000 Plan was amended in September 2001 to expand the form of
awards permitted under the plan to include installment and restricted stock.
Awards of non-statutory stock options, restricted stock and installment stock
(in the form of installment stock grants) have been made under the 2000 Plan. An
aggregate of 280,000 shares of eLoyalty common stock has been reserved for
issuance under the 2000 Plan.
If options or shares awarded under the 1999 Plan and the 2000 Plan are
not issued due to cancellation then those options or shares will again become
available for issuance under the plans. As of December 29, 2001, there were a
total of 589,466 shares available for future grants under the 1999 and 2000
Plans.
Stock options granted under the 1999 Plan and 2000 Plan are made at the
discretion of the Compensation Committee of eLoyalty's Board of Directors or
another duly constituted committee of the Board to the extent authorized
Page 39
ELOYALTY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share data)
by such plans and the Board (the "Compensation Committee"). Most employees are
eligible to receive a grant of non-statutory stock options periodically with the
number of shares generally determined by the employee's position grade,
performance level and the size of the award pool as determined by the
Compensation Committee. In addition, full-time employees normally receive a
grant of non-statutory stock options upon hire. Stock options are generally
granted with an exercise price per share equal to the fair market value of a
share of eLoyalty common stock on the date of grant and a maximum term of 10
years. Although the Compensation Committee has the authority to set other terms,
the options generally become exercisable over a period of four years. The
initial vesting may occur after a one or two-year period, with the balance of
the shares vesting in equal monthly installments over the remainder of the
four-year period, or the entire award may vest in equal monthly increments over
the four-year period.
The 1999 Plan was amended in December 2000 to increase the number of
option shares automatically awarded to non-employee directors. The 1999 Plan, as
amended, provides that each non-employee director will receive a non-statutory
stock option to purchase 5,000 shares of eLoyalty common stock when he or she
commences service as a director. In addition, on the day following the date of
each annual shareholders' meeting, each non-employee director will receive a
non-statutory stock option to purchase 1,200 shares of eLoyalty common stock.
Stock options granted to non-employee directors have an exercise price per share
equal to the fair market value of a share of eLoyalty common stock on the grant
date and a maximum term of 10 years. Stock options granted to non-employee
directors upon commencement of services vest ratably over a period of 48 months.
Stock options granted to non-employee directors following an annual
shareholders' meeting vest ratably over a period of 12 months.
At the time of the spin-off, each outstanding option to purchase TSC
common stock held by a person who was an employee or director of eLoyalty
immediately after the spin-off (and who was not also a director of TSC) was
converted into a substitute option to purchase eLoyalty common stock.
Furthermore, each outstanding TSC option granted before June 22, 1999 to a
person who was an employee or director of TSC after the spin-off, or who was
neither an employee or director of eLoyalty or TSC after the spin-off, was
converted into both an adjusted TSC option and a substitute eLoyalty option. The
conversion of the options was done in a manner such that (1) the aggregate
intrinsic value of the options immediately before and after the exchange were
the same, (2) the ratio of the exercise price per option to the market value per
option was not reduced, and (3) the vesting provisions and option period of the
replacement options are the same as the original vesting terms and option
period. Each substitute option takes into account all employment with both TSC
and eLoyalty for purposes of determining when the option becomes exercisable and
when it terminates. All other terms of the substitute option are the same as the
terms of the TSC option to which it relates. Of the 738,756 shares subject to
replacement options issued in connection with the spin-off, 355,782 shares were
subject to replacement options issued to persons who were employees or directors
of eLoyalty immediately after the spin-off.
Under the 1999 Plan, eLoyalty granted 119,500, net of cancellations
(and excluding shares issued in exchange for stock options as discussed below),
and 29,312 shares of restricted common stock to certain executives during the
year ending December 29, 2001 and December 30, 2000, respectively. During the
restricted period, the holders of such shares have the same rights as common
stockholders of eLoyalty, except that the shares may not be sold, assigned,
pledged or otherwise encumbered. Restrictions on shares granted in the second
quarter of 2001 lapse in equal monthly installments over a period of 48 months
beginning on (i) May 1, 2001 with respect to 83,500 shares, and (ii) May 1, 2003
with respect to 31,000 shares. Restrictions on 5,000 shares granted in 2001
and 22,901 shares, net of cancellations, granted in 2000 lapse ratably over a
period of 60 months beginning July 1, 2001 and August 1, 2000, respectively. As
of December 29, 2001, a total of 120,663 restricted common stock shares
(excluding shares issued in exchange for stock options) continued to be subject
to restrictions.
On November 9, 2001, eLoyalty authorized the exchange of certain
outstanding non-statutory stock options issued under the 1999 Plan and 2000
Plan, having an exercise price above $30 per share on a post-split basis and an
original term of no more than ten years, for awards of restricted and
installment common stock. Restricted Stock awards are shares of eLoyalty common
stock granted to an individual. During the restriction period, the holder of the
restricted stock receives all of the benefits of ownership (right to dividends,
voting rights, etc.), other than the right to sell or
Page 40
ELOYALTY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share data)
otherwise transfer any interest in the stock. Installment Stock awards are
grants to an individual of a contractual right to receive future grants of
eLoyalty common stock in specified amounts on specified dates, subject to the
individual remaining an eLoyalty employee on the date of the subject grant. With
respect to the installment stock awards made in connection with the exchange
offer, the grant dates are contemporaneous with the vesting dates for the
restricted stock granted in the exchange offer. In the exchange offer, eligible
US employees received one share of restricted stock for each share underlying
options tendered, with restrictions lapsing on such restricted shares in 20
equal quarterly installments beginning on February 28, 2002. Eligible non-US
employees received an installment stock award that provides for the issuance of
one share of common stock for each share underlying options tendered with the
issuance of such shares being made in 20 equal quarterly installments beginning
February 28, 2002. As a result of the exchange, which was voluntary, eLoyalty
accepted the tender of options to purchase approximately 573,097 shares of its
common stock, issued approximately 483,165 shares of restricted common stock to
its eligible US employees, and reserved for issuance to eligible non-US
employees approximately 89,932 shares of its common stock. Upon the exchange,
the aggregate fair value of the restricted stock issued and installment stock to
be issued, $2,980, was recorded as unearned compensation and will be amortized
to expense over the 20 quarter vesting or installment period.
Option activity was as follows for the years ending December 31, 1999,
December 30, 2000 and December 29, 2001: (All share and exercise prices have
been adjusted to reflect the one-for-ten reverse stock split.)
Option Weighted-Average Options
Shares Exercise Price Exercisable
------------------------------------------------------------------------------------------------------------
Outstanding as of December 31, 1998 -- $ -- --
------------------------------------------------------------------------------------------------------------
Granted 544,725 $ 38.80
Exercised -- $ --
Forfeited (10,725) $ 35.00
------------------------------------------------------------------------------------------------------------
Outstanding as of December 31, 1999 534,000 $ 38.90 --
------------------------------------------------------------------------------------------------------------
Granted 506,691 $ 209.10
Granted in connection
with the spin-off(1) 738,756 $ 68.50
Exercised (91,329) $ 62.40
Forfeited (190,838) $ 186.50
------------------------------------------------------------------------------------------------------------
Outstanding as of December 30, 2000 1,497,280 $ 90.90 594,143
------------------------------------------------------------------------------------------------------------
Granted 259,883 $ 27.59
Exercised (8,059) $ 57.17
Forfeited(2) (1,091,364) $ 96.49
------------------------------------------------------------------------------------------------------------
Outstanding as of December 29, 2001 657,740 $ 56.81 467,855
------------------------------------------------------------------------------------------------------------
(1) Includes options issued in connection with the spin-off in
substitution of previously granted TSC options.
(2) Includes options tendered in exchange for restricted stock and
installment stock awards.
Page 41
ELOYALTY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share data)
The following table summarizes the status of stock options outstanding
and exercisable as of December 29, 2001 by range of exercise price: (All share
and exercise prices have been adjusted to reflect the one-for-ten reverse stock
split.)
Options Outstanding Options Exercisable
----------------------------------------------------------------------------------- --------------------------------
Weighted-Average Weighted-Average Weighted-Average
Range of Number Remaining Contractual Exercise Price Number Exercise Price
Exercise Prices Outstanding Life (in Years) Per Share Exercisable Per Share
---------------------------------------------------------------------------------------------------------------------
$ 2.73--$ 19.99 223,062 8.3 $ 17.08 112,755 $ 17.45
$ 20.00--$ 39.99 188,987 9.0 $ 25.10 140,991 $ 23.98
$ 40.00--$ 79.99 110,154 7.9 $ 70.07 99,585 $ 70.93
$ 80.00--$139.99 78,801 6.8 $ 114.85 71,868 $ 114.82
$140.00--$366.25 56,736 8.1 $ 212.32 42,656 $ 203.33
---------------------------------------------------------------------------------------------------------------------
Total 657,740 8.2 $ 56.81 467,855 $ 62.71
---------------------------------------------------------------------------------------------------------------------
eLoyalty has elected to disclose the pro forma effects of SFAS No. 123,
"Accounting for Stock-Based Compensation" ("SFAS 123") and, as permitted under
SFAS 123, applies Accounting Principles Board Opinion No. 25 ("APB 25") and
related interpretations in accounting for its plans.
Under APB 25, compensation costs for employee stock options are
measured as the excess, if any, of the fair value of eLoyalty common stock at
the date of grant over the option exercise price, providing all other
requirements for fixed plan accounting are satisfied. Some option shares with
exercise prices below fair value were issued by eLoyalty in 1999 and 2000, thus
resulting in eLoyalty recording related compensation expense. During 2000,
eLoyalty cancelled and reissued options for 11,200 shares at a lower exercise
price. The cancellation and reissuance of these options was necessary to meet
commitments made to newly hired employees. These replacement options are
accounted for under variable plan accounting and the related compensation will
be subject to adjustment in the future periods based on the fluctuation of the
fair value of a share of eLoyalty's common stock. No compensation expense was
recognized for these reissued options during 2001 based on the fair value of
eLoyalty's common stock during 2001. Under APB No. 25, the fair value of
restricted shares at the date of grant is amortized to expense ratably over the
vesting period. eLoyalty recorded compensation expense related to awards of
restricted stock and installment stock awards, including awards issued in
exchange for stock options tendered, of approximately $1,161 for the year ended
December 29, 2001 and $520 for the year ended December 30, 2000.
eLoyalty is required under SFAS 123 to disclose pro forma information
regarding option grants made to its directors, officers and employees based on
specified valuation techniques that produce estimated compensation charges. The
fair value of eLoyalty options, including substitute options issued in
connection with the spin-off, were estimated at grant date using the
Black-Scholes option pricing model.
Page 42
ELOYALTY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share data)
The weighted average grant date fair value and the assumptions used in the
Black-Scholes model to calculate such fair values are shown below:
For the Year Ended For the Year Ended For the Year Ended
December 29, December 30, December 31,
Options 2001 2000 1999
---------------------------------------------------------------------------------------------------------------
Substitute TSC Options (1)
Expected volatility -- -- 49.7%--54.2%
Risk-free interest rates -- -- 4.6%--6.3%
Expected lives -- -- 4.5 years
Dividends -- -- --
Weighted average grant date fair value -- -- $ 50.80
--------------------------------------------------------------------------------------------------------------
eLoyalty Options
Expected volatility 50% 50% 50%
Risk-free interest rates 3.6%-5.0% 5.6%--6.8% 5.7%--6.3%
Expected lives 4.5 years 4.5 years 4.5 years
Dividends -- -- --
Weighted average grant date fair value
Issued above market prices $ -- $126.20 --
Issued at market prices $ 12.92 $ 53.10 $ 17.90
Issued below market prices $ -- $ 85.40 $ 86.20
---------------------------------------------------------------------------------------------------------------
(1) eLoyalty stock options issued in connection with the spin-off in
substitution of previously granted TSC options.
Had compensation costs for eLoyalty's stock option plans been
determined using the fair value method under SFAS 123, eLoyalty's net (loss)
income available to common stockholders and earnings (loss) per share would have
been reduced to the pro forma amounts indicated below:
For the Year Ended For the Year Ended For the Year Ended
December 29, December 30, December 31,
2001 2000 1999
---------------------------------------------------------------------------------------------------------------------------
Net (loss) income available to common stockholders:
As reported $ (67,237) $ (424) $ 4,058
Pro forma $ (73,628) $ (12,381) $ 1,219
Basic net (loss) income per share:
As reported $ (13.42) $ (0.09) $ 0.98
Pro forma $ (14.69) $ (2.57) $ 0.29
Diluted net (loss) income per share:
As reported $ (13.42) $ (0.09) $ 0.92
Pro forma $ (14.69) $ (2.57) $ 0.28
-------------------------------------------------------------------------------------------------------------------
Page 43
ELOYALTY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share data)
NOTE FOURTEEN--EARNINGS PER SHARE
The following table sets forth the computation of the income (loss) and
shares used in the calculation of basic and diluted earnings per share:
For the Years Ended December(1) (2)
--------------------------------------------------
December 29, December 30, December 31,
2001 2000 1999
------------------------------------------------------------------------------------------------------------
Net (loss) income $(63,661) $(424) $4,058
Series B preferred stock dividends and accretion (3,576) -- --
------------------------------------------------------------------------------------------------------------
Net (loss) income available to common stockholders $(67,237) $(424) $4,058
------------------------------------------------------------------------------------------------------------
Weighted average shares outstanding (in thousands) 5,011 4,823 4,140
Common stock equivalents (in thousands) 146 549 280
------------------------------------------------------------------------------------------------------------
Total weighted average shares and
common stock equivalents 5,157 5,372 4,420
------------------------------------------------------------------------------------------------------------
(1) In December 2001, eLoyalty effected a one-for-ten reverse stock split.
Share amounts presented for all prior periods reflect the effect of the
reverse split.
(2) In December 1999, eLoyalty issued approximately 4.1 million shares
(post-split) to TSC. For periods prior to February 15, 2000 the
weighted average shares outstanding is based on these 4.1 million
shares.
NOTE FIFTEEN--SEGMENT INFORMATION
We operate in one business segment focused exclusively on providing
customer relationship management ("CRM") related consulting services. Beginning
in 2001, as a result of organizational changes, we have two reportable
geographic segments. Those segments are: North America and International. Our
North American business includes our United States and Canadian operations. Our
International business includes operations in Europe and Australia. The
following table reflects revenues, operating results, and total assets by
reportable segment for the years ended December 2001, 2000 and 1999.
North
America International Total
----------------------------------------------------------------------------------------------------------------
Revenues
2001 $ 120,429 $ 26,300 $ 146,729
2000 $ 208,222 $ 28,276 $ 236,498
1999 $ 136,241 $ 26,939 $ 163,180
Operating income (loss)
2001 $ (64,658) $ (9,753) $ (74,411)
2000 $ 4,545 $ (8,314) $ (3,769)
1999 $ 14,902 $ (6,397) $ 8,505
Total assets
2001 $ 110,780 $ 17,234 $ 128,014
2000 $ 153,835 $ 30,783 $ 184,618
1999 $ 67,644 $ 28,959 $ 96,603
Page 44
ELOYALTY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share data)
Other Total
United North North United Other Total
States America America Germany Kingdom International International Total
-------------------------------------------------------------------------------------------------------------------------------
Revenues
2001 $113,208 $7,221 $120,429 $12,844 $10,686 $2,770 $26,300 $146,729
2000 $198,478 $9,744 $208,222 $10,339 $10,703 $7,234 $28,276 $236,498
1999 $127,715 $8,526 $136,241 $ 9,474 $11,934 $5,531 $26,939 $163,180
Total long-lived assets for our US operations are $19,055, $25,555, and
$13,223 for the years ended December 29, 2001, December 30, 2000 and December
31, 1999, respectively. At December 29, 2001, 99% of our revenues related to
services.
NOTE SIXTEEN--LEASES
eLoyalty leases various office facilities under operating leases
expiring at various dates through September 30, 2007. Additionally, eLoyalty
leases various property and office equipment under operating leases expiring at
various dates. Rental expense for all operating leases approximated $8,111,
$6,659, and $1,436 for the years ended December 29, 2001, December 30, 2000 and
December 31, 1999, respectively.
Future minimum rental commitments under noncancelable operating leases
with terms in excess of one year are as follows:
Year Amount
-----------------------------------------------
2002 $ 5,920
2003 4,560
2004 3,204
2005 1,910
2006 530
Thereafter 475
-----------------------------------------------
$ 16,599
-----------------------------------------------
Minimum payments have not been reduced by minimum sublease rentals of
$0.4 million, $0.3 million, $0.2 million and $0.2 million due in the future for
years 2002, 2003, 2004, and 2005, respectively, under noncancelable subleases.
Of the future minimum rental commitments, the Company has accrued as part of the
severance and related costs as discussed in Note Three, $2.5 million, $1.3
million, $0.6 million, $0.5 million and $0.6 million for 2002, 2003, 2004, 2005,
2006 and thereafter, respectively.
NOTE SEVENTEEN--COMMITMENTS AND CONTINGENCIES
eLoyalty has made a commitment to invest up to $14,700, through a
related entity, in eLoyalty Ventures, L.L.C. ("eLoyalty Ventures"). eLoyalty
Ventures is a $30,000 venture capital fund formed in 2000 by eLoyalty, together
with entities associated with Bain Capital, Sutter Hill and TCV, to focus on
investing in early-stage CRM technology companies. eLoyalty has not been
requested to contribute any of its eLoyalty Ventures commitment and so remains
subject to capital calls against that commitment on 10 business days' prior
written notice. While no formal action has been taken to suspend the fund's
activities, eLoyalty believes none of the members of eLoyalty Ventures would
recommend investment activity at this time. eLoyalty further believes that the
fund's management is not actively
Page 45
ELOYALTY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share data)
engaging in evaluation of investment opportunities. Accordingly, eLoyalty does
not expect any expenditures relating to this fund in 2002.
eLoyalty, from time to time, has been subject to legal claims arising
in connection with its business. While the results of these claims cannot be
predicted with certainty, at December 29, 2001 there were no asserted claims
against eLoyalty that, in the opinion of management, if adversely decided, would
have a material effect on eLoyalty's financial position, results of operations,
and cash flows.
NOTE EIGHTEEN--SUBSEQUENT EVENTS
In early 2002, management presented the Board of Directors with a
proposed compensation program (the "Program") for eLoyalty's Vice Presidents,
including those who previously held the title of Senior Vice President. As part
of the Program, each Vice President was assigned to one of five tiers and total
target cash compensation (base salary and target bonus) for all Vice Presidents
within each tier was made uniform. Among the goals of the Program was to more
closely align the interests of these senior level employees with those of the
Company's stockholders. To this end, under the Program, a target equity
ownership level in eLoyalty was set for each tier. The Program was approved by
the Compensation Committee of the Board of Directors on February 25, 2002 and
was ratified by the entire Board of Directors thereafter.
On February 28, 2002, each US Vice President received a grant of
restricted eLoyalty Common Stock in an amount such that, when combined with
previous equity grants to such Vice President, the aggregate equity granted to
such Vice President approximately equaled the target equity ownership level for
the tier to which such Vice President was assigned. The restrictions will lapse
on such stock in 20 equal quarterly installments, beginning on May 31, 2002.
Non-US Vice Presidents received an installment stock award that provides for the
issuance, in the aggregate, of the same number of shares of eLoyalty Common
Stock as would have been issued to them as restricted stock, had they been US
employees, in 20 equal quarterly installments, beginning on May 31, 2002.
Approximately 890,000 shares of eLoyalty Common Stock, in the aggregate, either
were granted as restricted stock or reserved for issuance under installment
stock grants in connection with the Program. Substantially all of this stock
came from the 1999 Plan and such stock constituted substantially all of the
stock then available for issuance under the 1999 Plan. This issuance will result
in an aggregate of $5,800 in non-cash compensation charges over the five year
restriction lapsing and installment grant period.
At eLoyalty's 2002 Annual Meeting of Stockholders, to be held on May
16, 2002, the stockholders will be asked to approve a 500,000 share increase in
the number of shares available for issuance under the 1999 Plan. This increase
will permit equity grants to be made to eLoyalty's President and Chief Executive
Officer, the size and form of which grant has not yet been determined, and
members of its Board of Directors, currently anticipated to be in the form of
options to purchase 50,000 shares of Common Stock per director, with a reserve
for grants to any additional directors added to the Board.
eLoyalty also has elected to freeze its Employee Stock Purchase Plan
immediately following the next quarterly purchase at the end of the first
quarter 2002. See also Note Eleven.
Page 46
ELOYALTY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share data)
NOTE NINETEEN--QUARTERLY DATA (UNAUDITED)
1st 2nd 3rd 4th Year
-----------------------------------------------------------------------------------------------------------------
For the Year Ended December 2001
Revenues $ 53,687 $ 38,267 $ 29,129 $ 25,646 $146,729
Operating loss $(27,116)(1) $(22,097)(2) $(15,617)(3) $ (9,581)(4) $(74,411)
Net loss available
to common stockholders $(16,477) $(29,913) $ (9,983) $(10,864)(5) $(67,237)
Basic net loss per share $ (3.30) $ (5.98) $ (1.99) $ (2.16) $ (13.42)
Diluted net loss per share(6) $ (3.30) $ (5.98) $ (1.99) $ (2.16) $ (13.42)
Shares used to calculate basic net
loss per share (in millions) (7) 5.00 5.00 5.01 5.04 5.01
Shares used to calculate diluted net
loss per share (in millions) (6)(7) 5.00 5.00 5.01 5.04 5.01
1st 2nd 3rd 4th Year
-------------------------------------------------------------------------------------------------------------------
For the Year Ended December 2000
Revenues $ 51,347 $ 56,964 $ 63,627 $ 64,560 $236,498
Operating loss $ (133) $ (2) $ (383) $ (3,251)(8) $ (3,769)
Net income (loss) available
to common stockholders $ 156 $ 406 $ 348 $ (1,334) $ (424)
Basic net income (loss) per share $ 0.04 $ 0.08 $ 0.07 $ (0.27) $ (0.09)
Diluted net income (loss) per share(6) $ 0.03 $ 0.08 $ 0.06 $ (0.27) $ (0.09)
Shares used to calculate basic net
(loss) income per share (in millions)(7) 4.43 4.79 4.97 4.98 4.82
Shares used to calculate diluted net
(loss) income per share (in millions)(6)(7) 4.99 5.31 5.44 4.98 4.82
(1) Includes $11,475 costs relating to severance and related costs associated
with cost reduction plans.
(2) Includes $10,719 costs relating to severance and related costs associated
with cost reduction plans.
(3) Includes $7,100 costs relating to severance and related costs associated
with cost reduction plans.
(4) Includes $4,150 costs relating to severance and related costs associated
with cost reduction plans.
(5) The fourth quarter of 2001 includes a $3,576 charge for Series B preferred
stock dividends and accretion.
(6) In periods of a loss, common stock equivalents were not included in the
calculation as they are antidilutive.
(7) All share amounts presented give effect to the one-for-ten reverse stock
split effected in December 2001.
(8) The fourth quarter of 2000 includes a $2,800 incremental charge for
uncollectable amounts due from clients.
Page 47
ELOYALTY CORPORATION
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
Balance at Balance
Description of Beginning at End of
Allowance and Reserves of Period Additions Deductions Period
------------------------------------------ ---------- ---------- ---------- ------
Valuation allowances for uncollectible amounts:
Year ended December 29, 2001 $1,605 4,512 (3,717) $2,400
Year ended December 30, 2000 $2,084 4,064 (4,543) $1,605
Year ended December 31, 1999 $2,638 2,059 (2,613) $2,084
Valuation allowances for deferred tax assets:
Year ended December 29, 2001 $ -- 14,080 -- $14,080
Year ended December 30, 2000 $ -- -- -- $ --
Year ended December 31, 1999 $ -- -- -- $ --
Page 48
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
For information about our executive officers, see "Executive Officers
of the Company" included as Item 4A of Part I of this report. The information
contained under the captions "Director Election - General" and "Security
Ownership of Certain Beneficial Owners and Management --- Section 16(a)
Beneficial Ownership Reporting Compliance" in the Proxy Statement to be filed by
eLoyalty for its 2002 Annual Meeting of Stockholders is incorporated herein by
reference in response to this item.
ITEM 11. EXECUTIVE COMPENSATION.
The information under "Director Election - Compensation of Directors"
and "Executive Compensation - Summary Compensation Table", "--- Compensation
Committee Interlocks and Insider Participation", "--- Option Grants in Fiscal
2001", "--- Option Exercises in Fiscal 2001 and Option Values at December 29,
2001", "--- Option Repricings", "--- Employment Contracts and Employment
Termination and Change in Control Arrangements" in the Proxy Statement to be
filed by eLoyalty for its 2002 Annual Meeting of Stockholders is incorporated
herein by reference in response to this item.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information under the heading "Security Ownership of Certain
Beneficial Owners and Management --- Beneficial Ownership Information" in the
Proxy Statement to be filed by eLoyalty for its 2002 Annual Meeting of
Stockholders is incorporated herein by reference in response to this item.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information under the caption "Certain Relationships and Related
Transactions" in the Proxy Statement to be filed by eLoyalty for its 2002 Annual
Meeting of Stockholders is incorporated herein by reference in response to this
item.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K.
(a) Documents filed as part of this report:
(1) Financial Statements.
The consolidated financial statements filed as part of this report
are listed and indexed under Item 8 of this Form 10-K, and such list
is incorporated herein by reference.
Page 49
(2) Financial Statement Schedule.
The financial statement schedule filed as part of this report is
listed and indexed under Item 8 of this Form 10-K, and is
incorporated herein by reference. We have omitted financial statement
schedules other than that listed under Item 8 because such schedules
are not required or applicable.
(3) Exhibits.
The list of exhibits filed with or incorporated by reference into
this report is contained in the Exhibit Index to this report on Page
I-1, which is incorporated herein by reference.
(b) Reports on Form 8-K:
eLoyalty filed the following Current Reports on Form 8-K during the fourth
quarter of 2001:
(1) On December 14, 2001, eLoyalty filed a Form 8-K reporting under Item 5
thereof the purchase price for sales of its 7% Series B Convertible
Preferred Stock in its previously announced private placement and
rights offering.
(2) On December 18, 2001, eLoyalty filed a Form 8-K reporting under Item 5
thereof its new $15 million revolving credit facility with LaSalle Bank
National Association.
(3) On December 19, 2001, eLoyalty filed a Form 8-K reporting under Item 5
thereof the voting results from its December 18, 2001 Special Meeting
of Stockholders.
(4) On December 21, 2001, eLoyalty filed a Form 8-K reporting under Item 5
thereof the completion of its previously announced private placement
and rights offering.
Page 50
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this Annual Report on Form 10-K to
be signed on its behalf by the undersigned, thereunto duly authorized, on March
28, 2002.
eLOYALTY CORPORATION
By /s/ KELLY D. CONWAY
----------------------
Kelly D. Conway
President and Chief
Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Annual Report on Form 10-K has been signed below by the following persons
on behalf of the registrant in the capacities indicated on this 28th day of
March 2002.
Name Capacity
---- --------
/s/ KELLY D. CONWAY Director, President and Chief
--------------------------------- Executive Officer (Principal
Kelly D. Conway Executive Officer)
*
--------------------------------- Chairman of the Board and Director
Tench Coxe
*
--------------------------------- Director
Jay C. Hoag
*
--------------------------------- Director
John T. Kohler
*
--------------------------------- Director
Michael J. Murray
/s/ TIMOTHY J. CUNNINGHAM Vice President, Chief Financial
--------------------------------- Officer and Corporate Secretary
Timothy J. Cunningham (Principal Financial and
Accounting Officer)
*By: /s/ TIMOTHY J. CUNNINGHAM
--------------------------------------
Timothy J. Cunningham, Attorney-in-Fact
Page 51
EXHIBIT INDEX
We are including as exhibits to this Annual Report on Form 10-K certain
documents that we have previously filed with the Securities and Exchange
Commission (" SEC") as exhibits, and we are incorporating such documents as
exhibits herein by reference from the respective filings identified in
parentheses below. The management contracts and compensatory plans or
arrangements required to be filed as exhibits to this Annual Report on Form 10-K
pursuant to Item 14(c) are those listed below as Exhibits 10.11 through 10.26,
inclusive, and Exhibits 10.32 through 10.38, inclusive.
EXHIBIT NO. DESCRIPTION OF EXHIBIT
----------- ----------------------
3.1 Certificate of Incorporation of eLoyalty, as amended (filed
as Exhibit 3.1 to eLoyalty's Registration Statement on Form
S-1 (Registration No. 333-94293) (the "S-1")).
3.2 Certificate of Designation of Series A Junior Participating
Preferred Stock of the Company (included as Exhibit 4.2 to
Amendment No.1 to eLoyalty's Registration Statement on Form
8-A (File No. 0-27975) filed with the SEC on March 24, 2000
(the "8-A Amendment")).
3.3+ Certificate of Amendment to eLoyalty's Certificate of
Incorporation, effective 7:59a.m., eastern time, December
19, 2001.
3.4+ Certificate of Amendment to eLoyalty's Certificate of
Incorporation, effective 7:58a.m., eastern time, December
19, 2001.
3.5+ Certificate of Increase of Series A Junior Participating
Preferred Stock of eLoyalty, filed December 19, 2001.
3.6+ Certificate of Designation of 7% Series B Convertible
Preferred Stock of eLoyalty, filed December 19, 2001.
3.7 By-Laws of eLoyalty (filed as Exhibit 3.2 to the S-1).
4.1 Rights Agreement, dated as of March 17, 2000, between
eLoyalty and ChaseMellon Shareholder Services, L.L.C., as
Rights Agent (filed as Exhibit 4.1 to the 8-A Amendment).
4.2 Amendment, dated as of September 24, 2001, to the Rights
Agreement between eLoyalty and Mellon Investor Services LLC
(filed as Exhibit 4.2 to eLoyalty's Current Report on Form
8-K dated September 24, 2001, File No. 0-27975).
4.3+ Certificate of Adjustment dated January 10, 2002.
I-1
10.1 Form of Reorganization Agreement between Technology
Solutions Company ("TSC") and eLoyalty Corporation
("eLoyalty") (included as Exhibit 2.1 to the S-1).
10.2 Common Stock Purchase Agreement, dated as of May 26, 2000,
among eLoyalty Corporation and TCV IV, L.P., TCV IV
Strategic Partners, L.P., TCV III (GP), TCV III (Q), L.P.
and TCV III Strategic Partners, L.P. (filed as Exhibit 10.1
to eLoyalty's Quarterly Report on Form 10-Q for the quarter
ended June 30, 2000 (File No. 0-27975)).
10.3 Amended and Restated Business Loan Agreement, dated as of
December 30, 2000, between eLoyalty Corporation and Bank of
America, N.A. (filed as Exhibit 10.5 to eLoyalty's Annual
Report on Form 10-K for the year ended December 30, 2000).
10.4 Form of Tax Sharing and Disaffiliation Agreement between
TSC and eLoyalty (filed as Exhibit 10.6 to the S-1).
10.5 Form of TSC (Licensor) Intellectual Property License
Agreement (filed as Exhibit 10.7 to the S-1).
10.6 Form of eLoyalty (Licensor) Intellectual Property License
Agreement (filed as Exhibit 10.8 to the S-1).
10.7 Office Lease -- Two Conway Park made as of December 6, 1999
by and between Riggs & Company, a division of Riggs Bank,
N.A., as Landlord, and eLoyalty Corporation, as Tenant
(filed as Exhibit 10.13 to the S-1).
10.8 River Place Point II Lease Agreement, dated March 17, 2000,
by and between Investors Life Insurance Company of North
America, as Landlord, and eLoyalty Corporation, as Tenant
(filed as Exhibit 10.15 to eLoyalty's Annual Report on Form
10-K for the year ended December 31, 1999 (File No.
0-27975)).
10.9 eLoyalty Ventures, L.L.C. Operating Agreement, dated as of
July 21, 2000, by and among Brookside Capital Partners Fund
LP, Sutter Hill Ventures L.P., TCV IV, L.P. and TCV
Strategic Partners IV, L.P. and eLoyalty Employee
Investors, L.L.C. (filed as Exhibit 10.2 to eLoyalty's
Quarterly Report on Form 10-Q for the quarter ended
September 30, 2000 (File No. 0-27975)).
10.10 eLoyalty Employee Investors, L.L.C. Operating Agreement,
entered into in July 2000, among eLoyalty Employee
Investors, L.L.C., eLoyalty Corporation as the initial
member and Sarah Faux as the manager (filed as Exhibit
10.13 to eLoyalty's Annual Report on Form 10-K for the year
ended December 30, 2000 (File No. 0-27975)).
10.11 eLoyalty Corporation 1999 Stock Incentive Plan (as Amended
and Restated as of February 28, 2001) (filed as Exhibit
10.14 to eLoyalty's Annual Report on Form 10-K for the year
ended December 30, 2000 (File No. 0-27975)).
10.12 eLoyalty Corporation 2000 Stock Incentive Plan (as Amended
and Restated as of September 24, 2001) (filed as Exhibit
(d)(2) to eLoyalty's Tender Offer Statement on Schedule TO
filed October 15, 2001).
10.13+ 1999 Employee Stock Purchase Plan (as Amended and Restated
as of November 6, 2001).
I-2
10.14 eLoyalty Corporation Executive Deferred Compensation Plan
dated January 1, 2000 (filed as Exhibit 10.14 to the S-1).
10.15 Summary of Discretionary Cash Bonus Program for Executive
Officers (filed as Exhibit 10.18 to eLoyalty's Annual
Report on Form 10-K for the year ended December 30, 2000
(File No. 0-27975)).
10.16 Employment Agreement, dated as of January 19, 1996, between
Kelly D. Conway and TSC (to which eLoyalty has succeeded)
(filed as Exhibit 10.9 to the S-1).
10.17 Promissory Note, dated November 12, 1998, by Kelly D.
Conway in favor of TSC (filed as Exhibit 10.12 to the S-1).
10.18 Promissory Note, dated December 15, 1999, by Kelly D.
Conway in favor of TSC (filed as Exhibit 10.21 to
eLoyalty's Annual Report on Form 10-K for the year ended
December 30, 2000 (File No. 0-27975)).
10.19 Employment Agreement, dated as of October 20, 1998, between
Craig Lashmet and TSC (to which eLoyalty has succeeded)
(filed as Exhibit 10.11 to the S-1).
10.20 Employment Agreement, dated as of November 15, 1999,
between Timothy J. Cunningham and TSC (to which eLoyalty
has succeeded) (filed as Exhibit 10.10 to the S-1).
10.21 Promissory Note, dated November 19, 1999, of Timothy J.
Cunningham in favor of TSC (to which eLoyalty has
succeeded) (filed as Exhibit 10.24 to eLoyalty's Annual
Report on Form 10-K for the year ended December 30, 2000
(File No. 0-27975)).
10.22 Contract of Employment, entered into May 12, 2000, between
eLoyalty (UK) Limited and Vaughan Thomas (filed as Exhibit
10.1 to eLoyalty's Quarterly Report on Form 10-Q for the
quarter ended September 30, 2000 (File No. 0-27975)).
10.23 Form of Loan Note, dated July 1, 2000, of Vaughan Thomas in
favor of eLoyalty (UK) Ltd. (filed as Exhibit 10.3 to
eLoyalty's Quarterly Report on Form 10-Q for the quarter
ended September 30, 2000 (File No. 0-27975)).
10.24 Form of Indemnification Agreement entered into between
eLoyalty Corporation and each of Tench Coxe and Jay C. Hoag
(filed as Exhibit 10.15 to the S-1).
10.25+ Promissory Note, dated December 28, 2001, of Kelly D.
Conway in favor of eLoyalty Corporation.
10.26+ Compromise Agreement, dated as of December 18, 2001,
between eLoyalty (UK) Limited and Vaughan Thomas.
10.27+ Loan Agreement, dated as of December 17, 2001, between
eLoyalty Corporation and LaSalle Bank National Association,
together with Amendment No. 1 to Loan Agreement, dated as
of February 27, 2002.
I-3
10.28 Share Purchase Agreement, dated as of September 24, 2001,
by and among eLoyalty and the Investors named therein
(filed as Exhibit 10.1 to eLoyalty's Current Report on Form
8-K dated September 24, 2001, File No. 0-27975).
10.29+ Amendment No. 1 to Share Purchase Agreement, dated as of
December 19, 2001, by and among eLoyalty and the investors
named therein.
10.30+ Amended and Restated Investor Rights Agreement, dated as of
December 19, 2001, by and among eLoyalty and the
stockholders named therein.
10.31 Amendment No. 1 to the Amended and Restated Business Loan
Agreement, dated as of September 28, 2001, between Bank of
America, N.A. and eLoyalty (filed as Exhibit 10.1 to
eLoyalty's Quarterly Report on Form 10-Q for the quarter
ended September 29, 2001, File No. 0-27975).
10.32 Employment Agreement, dated January 2 and 8, 2001, and
effective January 29, 2001, between Jay A. Istvan and
eLoyalty (filed as Exhibit 10.1 to eLoyalty's Quarterly
Report on Form 10-Q for the quarter ended March 31, 2001,
File No. 0-27975).
10.33 Promissory Note dated February 20, 2001, of Jay A. Istvan
in favor of eLoyalty (filed as Exhibit 10.2 to eLoyalty's
Quarterly Report on Form 10-Q for the quarter ended March
31, 2001, File No. 0-27975).
10.34 Letter agreement, dated January 2, 2001, between Jay A.
Istvan and eLoyalty (filed as Exhibit 10.3 to eLoyalty's
Quarterly Report on Form 10-Q for the quarter ended March
31, 2001, File No. 0-27975).
10.35 Indemnification Agreement, effective as of January 29,
2001, between Jay A. Istvan and eLoyalty (filed as Exhibit
10.4 to eLoyalty's Quarterly Report on Form 10-Q for the
quarter ended March 31, 2001, File No. 0-27975).
10.36 Employment Agreement, effective June 1, 2001, between
Steven C. Pollema and eLoyalty (filed as Exhibit 10.1 to
eLoyalty's Quarterly Report on Form 10-Q for the quarter
ended June 30, 2001, File No. 0-27975).
10.37 Promissory Note, dated June 1, 2001, of Steven C. Pollema
in favor of eLoyalty (filed as Exhibit 10.2 to eLoyalty's
Quarterly Report on Form 10-Q for the quarter ended June
30, 2001, File No. 0-27975).
10.38 Indemnification Agreement, dated June 11, 2001, between
Steven C. Pollema and eLoyalty (filed as Exhibit 10.3 to
eLoyalty's Quarterly Report on Form 10-Q for the quarter
ended June 30, 2001, File No. 0-27975).
21.1+ Subsidiaries of eLoyalty Corporation
23.1+ Consent of PricewaterhouseCoopers LLP.
24.1+ Power of Attorney from Tench Coxe, Director
24.2+ Power of Attorney from Jay C. Hoag, Director
24.3+ Power of Attorney from John T. Kohler, Director
24.4+ Power of Attorney from Michael J. Murray, Director
----------------
+ Filed herewith
I-4