Annual Report — Form 10-K
Filing Table of Contents
Document/Exhibit Description Pages Size
1: 10-K Annual Report 17 90K
4: EX-10.13 Eloyalty Employee Investors, LLC Operating Agrmt 4 14K
5: EX-10.14 Eloyalty Corp. 1999 Stock Incentive Plan 15 90K
6: EX-10.15 Eloyalty Corp. 2000 Stock Incentive Plan 8 48K
7: EX-10.16 1999 Employee Stock Purchase Plan 9 37K
8: EX-10.18 Summary of Discretionary Cash Bonus Program 2 12K
9: EX-10.21 Promissory Note by Kelly D Conway 4 20K
10: EX-10.24 Promissory Note of Timothy J Cunningham 4 21K
11: EX-10.27 Employment Agrmt Between Christopher J Danson 4 22K
12: EX-10.28 Promissory Note of Christopher J Danson 5 25K
13: EX-10.29 Promissory Note of Christopher J Danson 4 20K
2: EX-10.4 Amendment to Investor Rights Agreement 2 13K
3: EX-10.5 Amended and Restated Business Loan Agreement 15 78K
14: EX-13.1 Excerpted Portions of 2000 Annual Report 29 177K
15: EX-21.1 Subsidiaries of Eloyalty Corporation 1 8K
16: EX-23.1 Consent of Pricewaterhousecoopers LLP 1 9K
17: EX-24.1 Power of Attorney From Tench Coxe, Director 1 10K
18: EX-24.2 Power of Attorney From Jay C Hoag, Director 1 10K
19: EX-24.3 Power of Attorney From John T Kohler, Director 1 10K
20: EX-24.4 Power of Attorney From Michael D. Murray, Director 1 10K
21: EX-24.5 Power of Attorney From John R Purcell, Director 1 10K
EX-13.1 — Excerpted Portions of 2000 Annual Report
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EXHIBIT 13.1
SELECTED FINANCIAL DATA
The following tables summarize selected financial data of eLoyalty(TM). 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 Annual
Report. The statements of operations data for the years ended 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, 1997 and 1996, and the balance sheet
data as of 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, for the seven month period
ended December 31, 1997 and for the year ended May 31, 1995, and the balance
sheet data as of May 31, 1996 and 1995 are derived from the unaudited financial
statements. In the opinion of management, the unaudited financial statements
discussed above reflect all adjustments, consisting of normal adjustments,
necessary to present fairly eLoyalty's results of operations for the year ended
December 31, 1998, for the seven month period ended December 31, 1997 and for
the year ended May 31, 1995, and its financial position as of May 31, 1996 and
1995.
The financial information for periods prior to February 15, 2000 reflect
eLoyalty's results of operations and financial position as it operated within
Technology Solutions Company ("TSC"), and the financial information for periods
subsequent to February 15, 2000 reflect eLoyalty's results of operations and
financial position as it 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 of
eLoyalty would have been had eLoyalty operated as a separate, stand-alone
publicly traded entity during such periods presented.
STATEMENTS OF OPERATIONS DATA
eLoyalty Corporation
[Enlarge/Download Table]
FOR THE
SEVEN MONTH
PERIOD ENDED
FOR THE YEARS ENDED DECEMBER DECEMBER FOR THE YEARS ENDED MAY
---------------------------- -------------- ----------------------------------
(In thousands, except per share data) 2000 1999 1998 1998 1997 1998 1997 1996 1995
------------------------------------------------------------------------------------------------------------------------------------
(unaudited) (unaudited) (unaudited)
Revenues $211,603 $146,003 $105,235 $64,415 $43,668 $84,488 $43,181 $26,516 $6,132
Project personnel costs 104,203 68,483 47,764 29,562 21,149 39,049 16,908 10,954 2,967
-------- -------- -------- ------- ------- ------- ------- ------- ------
Gross profit 107,400 77,520 57,471 34,853 22,519 45,439 26,273 15,562 3,165
-------- -------- -------- ------- ------- ------- ------- ------- ------
Other costs and expenses:
Selling, general and administrative 96,875 58,395 46,665 29,132 18,269 35,436 19,290 10,609 3,344
Research and development 9,322 5,624 3,882 3,089 1,483 2,543 1,799 46 --
Goodwill amortization 4,972 4,996 3,794 2,450 1,856 3,201 376 -- --
-------- -------- -------- ------- ------- ------- ------- ------- ------
Total other expenses 111,169 69,015 54,341 34,671 21,608 41,180 21,465 10,655 3,344
-------- -------- -------- ------- ------- ------- ------- ------- ------
Operating (loss) income (3,769) 8,505 3,130 182 911 4,259 4,808 4,907 (179)
-------- -------- -------- ------- ------- ------- ------- ------- ------
Other income (loss) 2,921 (408) (391) (327) (14) (24) 15 -- --
-------- -------- -------- ------- ------- ------- ------- ------- ------
(Loss) income before income taxes (848) 8,097 2,739 (145) 897 4,235 4,823 4,907 (179)
Income tax (benefit) provision (424) 4,039 1,672 398 562 2,022 1,897 1,857 (51)
-------- -------- -------- ------- ------- ------- ------- ------- ------
Net (loss) income $ (424) $ 4,058 $ 1,067 $ (543) $ 335 $ 2,213 $ 2,926 $ 3,050 $ (128)
======== ======== ======== ======= ======= ======= ======= ======= ======
Basic net (loss) income per common share(1) $ (0.01) $ 0.10 $ 0.03 $ (0.01) $ 0.01 $ 0.05 $ 0.07 $ 0.07 $(0.00)
Diluted net (loss) income per common share(1)(2) $ (0.01) $ 0.09 $ 0.02 $ (0.01) $ 0.01 $ 0.05 $ 0.06 $ 0.07 $(0.00)
(In millions)
Basic weighted average shares outstanding(1) 48.2 41.4 41.4 41.4 41.4 41.4 41.4 41.4 41.4
Dilutive weighted average shares outstanding(2) 53.7 44.2 43.1 NA(3) 45.8 46.8 46.6 45.5 NA(3)
(1) In December 1999, eLoyalty issued 41.4 million shares to Technology
Solutions Company. For periods prior to February 15, 2000, basic earnings
per share has been computed based on the 41.4 million shares and diluted
earnings per share has been computed based on the 41.4 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.
(2) In periods of a loss, common stock equivalents were not included in the
calculation as they are antidilutive.
(3) Dilutive share information is not available for these periods (see Note
Thirteen to the Financial Statements).
22
SELECTED FINANCIAL DATA (CONT.)
BALANCE SHEET DATA
[Enlarge/Download Table]
AS OF DECEMBER 30, AS OF DECEMBER 31, AS OF MAY 31,
------------------ ------------------ --------------------------------------------------
(In thousands) 2000 1999 1998 1998 1997 1996 1995
-------------------------------------------------------------------------------------------------------------------------
(unaudited) (unaudited)
Cash $ 41,138 $ 13,462 $ 4,411 $ 4,726 $ 4,130 $ 321 $ --
Working capital $109,934 $ 54,927 $ 26,231 $ 23,840 $ 13,506 $ 6,249 $ 3,130
Total assets $184,618 $ 96,603 $ 63,904 $ 54,118 $ 24,188 $ 14,008 $ 4,351
Stockholders' equity $140,856 $ 73,615 $ 47,888 $ 40,893 $ 17,147 $ 9,312 $ 3,169
COMMON STOCK INFORMATION
eLoyalty completed its 100% spin-off from Technology Solutions Company and began
public trading on February 16, 2000. The 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.
[Download Table]
PRICE RANGE: High Low
--------------------------
First Quarter (beginning February 16, 2000) $ 40.50 $ 18.44
Second Quarter $ 24.00 $ 10.50
Third Quarter $ 18.13 $ 9.88
Fourth Quarter $ 12.88 $ 3.19
Dividends
Historically, eLoyalty has not paid cash dividends on its common stock and does
not anticipate paying cash dividends in the foreseeable future.
23
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management's Discussion and other parts of this Annual Report
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 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 this Annual Report. Readers should also carefully review the risk
factors described in other documents eLoyalty(TM) files from time to time with
the SEC, including eLoyalty's Annual Report on Form 10-K for the fiscal year
ended December 30, 2000.
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 eLoyalty 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.
OVERVIEW
eLoyalty is a global management consulting and systems integration organization
focused exclusively on building customer loyalty. eLoyalty has 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").
Accordingly, the statements of operations for periods subsequent to the spin-off
reflect eLoyalty's 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 includes a cost allocation of certain TSC
general corporate expenses that were not directly related to eLoyalty's
operations. These costs were allocated proportionately to eLoyalty based on
revenues and headcount.
Certain reclassifications have been made in the statements of operations
for the years ended 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 2000 presentation. In December 2000, eLoyalty changed its 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 2000 is December 30. eLoyalty had
previously changed its fiscal year-end from May 31 to December 31, effective
December 31, 1998. For comparative purposes, eLoyalty has included discussions
of 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 to present fairly eLoyalty's results of operations
for the year ended December 31, 1998 and the seven month period ended December
31, 1997.
eLoyalty's revenues are generated primarily from professional services,
which are billed principally on a time and materials basis. eLoyalty has, on
occasion, contracted projects on a fixed fee basis. Revenues are recognized for
time and material engagements as services are rendered.
24
Other growing revenue contributors include fees generated from Managed
Services (including Loyalty Support(TM) services, purpose-built hosted solutions
and e-PROFILE(TM)) and the licensing of proprietary software. These revenues
comprised 6% and 3% of revenues in 2000 and 1999, respectively.
Our revenues from international operations represent revenues in Canada,
Europe and Australia. International operations represented 17% and 22% of
revenues for the years ended December 30, 2000 and December 31, 1999,
respectively.
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 vacation periods. Although those decreases in revenues have not been
significant in the past, they may increase in the future, especially as we
expand internationally.
eLoyalty's most significant operating cost is project personnel costs,
which are comprised of labor costs including salaries, fringe benefits and
incentive compensation of engageable consultants, as well as fees paid to
subcontractors for work performed on an engagement.
Gross profit represents our revenues less project personnel costs. We
anticipate that to the extent we have additional software and Managed Services
revenues, our gross margins will increase. Gross profit margins, which have
declined as a percent of revenue over the last three years, are negatively
impacted by several factors, including the use of subcontractors and
non-billable time incurred by project personnel.
Selling, general and administrative expenses consist primarily of salaries,
incentive compensation and employee benefits for business development,
marketing, managerial and administrative personnel, plus provisions for
doubtful receivables. Other overhead expenses consist of employee costs for
training, travel expenses, laptop computer leases and other non-billable
expenses not directly related to projects or research and development. This
would also include 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.
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.
Historically, our effective tax rate has fluctuated significantly. For some
periods, our effective tax rate was unusually high. The high effective tax rates
were due primarily to the generation of pre-tax losses in low tax-rate
jurisdictions and pre-tax earnings in high tax-rate jurisdictions. During 2000,
we began implementing an organizational structure, which we expect to lower
our effective tax rate in future years.
YEAR ENDED DECEMBER 30, 2000 COMPARED WITH THE YEAR ENDED DECEMBER 31, 1999
REVENUES
Our revenues increased $65.6 million, or 45%, to $211.6 million in 2000 from
$146.0 million in 1999. Revenues from professional fees increased $57.3 million,
or 41%, to $198.3 million in 2000 from $141.0 million in 1999. The increase in
revenues is due to the combined effect of strong demand for the CRM services
provided by eLoyalty and higher average billing rates in the period-over-period
comparison.
Revenues from Managed Services increased $5.9 million to $7.8 million in
2000 from $1.9 million in 1999. Managed Services revenues represented 4% 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 17% of total revenues in 2000, compared to 22% in 1999.
25
PROJECT PERSONNEL COSTS
Project personnel costs increased $35.7 million, or 52%, to $104.2 million in
2000 from $68.5 million in 1999. This is due to an increase in the number of our
engageable consultants to 768 as of December 30, 2000, or 37%, from 561 for
1999. Project personnel costs as a percentage of revenues increased to 49% in
2000 compared to 47% in 1999. This was due, in part, to the approximately $5.9
million of incremental project personnel costs incurred in 2000 as part of the
expansion of our Managed Services.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses increased $38.5 million, or 66%, to
$96.9 million in 2000 from $58.4 million in 1999. This increase is the result of
the growth of eLoyalty and the build-out of eLoyalty's standalone
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
uncollectable 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 $3.7 million, or 66%, to $9.3
million in 2000 from $5.6 million in 1999. This increase is primarily due to an
increased investment in the Loyalty Lab, including the addition of developers.
GOODWILL AMORTIZATION
Goodwill amortization expenses were $5.0 million for both 2000 and 1999.
Goodwill amortization is primarily attributable to the acquisition of The
Bentley Group in 1997.
OTHER INCOME (LOSS)
eLoyalty recognized non-operating other income of $2.9 million in 2000 compared
to a non-operating other loss 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 balance is 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
eLoyalty reported a net loss of $0.4 million, or $0.01 per share on a diluted
basis, for fiscal year 2000 as compared with net income of $4.1 million, or
$0.09 per share on a diluted basis, for 1999. The 2000 results are reflective
of the $3.8 million operating loss for the fiscal 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.
YEAR ENDED DECEMBER 31, 1999 COMPARED WITH THE YEAR ENDED DECEMBER 31, 1998
(UNAUDITED)
REVENUES
Revenues increased $40.8 million, or 39%, to $146.0 million in 1999 from $105.2
million in 1998. Revenues from professional services increased $36.8 million, or
35%, to $141.0 million in 1999 from $104.2 million in 1998. The increase in our
revenues reflected increases in both the size and number of client projects, as
well as higher average billing rates.
26
Revenues from software were $3.1 million in 1999 compared to $1.0 million
in 1998. Revenues from Loyalty Support increased to $1.9 million in 1999 from
$0.0 million in 1998, as we launched our Loyalty Support services during 1999.
Revenues from international operations remained consistent, at approximately 22%
of total revenues, in both 1999 and 1998.
PROJECT PERSONNEL COSTS
Project personnel costs increased $20.7 million, or 43%, to $68.5 million in
1999 from $47.8 million in 1998. The number of our engageable consultants
increased to 561 as of December 31, 1999, or 40%, from 402 at year-end 1998. The
increase in project personnel costs in 1999 was also due to an increase in the
use of subcontractors, which have a higher average cost, that were required to
meet demand. Project personnel costs as a percentage of revenues increased to
47% in 1999 compared to 45% in 1998.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses increased $11.7 million, or 25%, to
$58.4 million in 1999 from $46.7 million in 1998. Selling and marketing expenses
increased primarily as a result of our decision to invest in brand building with
respect to the launch of our new identity as eLoyalty and to formalize our
business development group. We also increased our sales and marketing staff
with the launch of our solutions marketing group. General and administrative
support expenses increased due to the continued growth of eLoyalty.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses increased $1.7 million, or 44%, to $5.6
million in 1999 from $3.9 million in 1998. In 1999 we substantially increased
our investment in our Loyalty Lab by hiring additional developers and purchasing
additional software and hardware.
GOODWILL AMORTIZATION
Goodwill amortization expense increased $1.2 million, or 32%, to $5.0 million in
1999 from $3.8 million in 1998 related to the acquisition of The Bentley Group.
INCOME TAX (BENEFIT) PROVISION
Income tax (benefit) provision represents combined federal, state and foreign
taxes. Our income tax provision increased to $4.0 million on pre-tax profits of
$8.1 million in 1999, compared to $1.7 million on pre-tax profits of $2.7
million in 1998. Our effective tax rate was 50% for 1999 and 61% for 1998. This
decrease in the effective tax rate was primarily the result of a lower
proportion of pre-tax earnings being generated in foreign high tax rate
jurisdictions.
NET (LOSS) INCOME
eLoyalty reported net income of $4.1 million, or $0.09 per share on a diluted
basis, for fiscal year 1999 as compared with net income of $1.1 million, or
$0.02 per share on a diluted basis, for 1998.
SEVEN MONTH PERIOD ENDED DECEMBER 31, 1998 COMPARED WITH THE SEVEN MONTH PERIOD
ENDED DECEMBER 31, 1997 (UNAUDITED)
REVENUES
Revenues increased $20.7 million, or 47%, to $64.4 million in the seven month
period ended December 31, 1998 from $43.7 million in the seven month period
ended December 31, 1997. The increase in our revenues of $20.7 million
reflected increases in both the size and number of client projects, as well as
higher average billing rates.
Revenues from sales of software were $1.0 million in the seven month period
ended December 31, 1998 compared to revenues of $0.2 million from sales of
software in the seven month period ended December 31, 1997. Revenues from our
international operations also significantly contributed to this increase in
revenue. In addition, The Bentley Group acquisition contributed approximately
$7.8 million of revenues in the seven month period ended December 31, 1997.
27
PROJECT PERSONNEL COSTS
Project personnel costs increased $8.5 million, or 40%, to $29.6 million in the
seven month period ended December 31, 1998 from $21.1 million in the prior year
period. The increase in project personnel costs was primarily due to an increase
in engageable consultants, as well as higher salaries. Project personnel costs
as a percentage of revenues decreased to 46% in the seven month period ended
December 31, 1998 compared to 48% in the prior period, principally due to higher
utilization of project personnel.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses increased $10.8 million, or 59%, to
$29.1 million in the seven month period ended December 31, 1998 from $18.3
million in the comparable period in the prior year. Selling and marketing
expenses increased primarily as a result of establishing our business
development group in North America and beginning our sales activities in Europe
and Australia. In addition, we established a $2.7 million provision for
uncollectable accounts receivable related to revenues generated during the seven
month period, largely from clients of The Bentley Group.
General and administrative support expenses increased as eLoyalty launched
our operations group to manage utilization, hourly billing rate, revenue per
billable employee, employee turnover and day-to-day project pipeline
development. During this period, we also increased the support level for our
operations in Europe and Australia.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses increased $1.6 million, or 108%, to $3.1
million in the seven month period ended December 31, 1998 from $1.5 million in
the comparable period in the prior year. This increase resulted from the
significant expansion of the scope and operations of our Loyalty Lab.
GOODWILL AMORTIZATION
Goodwill amortization expenses increased $0.6 million, or 32%, to $2.5 million
in the seven month period ended December 31, 1998 from $1.9 million in the
comparable period in the prior year. This increase was attributable to the
contingent purchase price payments related to the acquisitions of The Bentley
Group and Aspen Consultancy Ltd.
INCOME TAX (BENEFIT) PROVISION
Income tax provision decreased to $0.4 million on a pre-tax loss of $0.1 million
at the end of the seven month period ended December 31, 1998 compared to $0.6
million on pre-tax profits of $0.9 million at the end of the comparable period
in the prior year. This unusual income tax provision for the seven month period
ended December 31, 1998 resulted from the impact of nondeductible goodwill and
expenses, as well as foreign tax rate differences. During the seven months ended
December 31, 1998, operations in some foreign jurisdictions incurred taxable
losses while other foreign jurisdictions had taxable income. Since deferred tax
assets are based on the individual tax jurisdictions in which eLoyalty operates,
net operating losses were generated during the period.
NET (LOSS) INCOME
eLoyalty reported a net loss of $0.5 million, or $0.01 per share on a diluted
basis, for the seven month period ended December 31, 1998 as compared with net
income of $0.3 million, or $0.01 per share on a diluted basis, for the
comparable period in the prior year.
FISCAL YEAR ENDED MAY 31, 1998 COMPARED WITH FISCAL YEAR ENDED MAY 31, 1997
REVENUES
Revenues increased $41.3 million, or 96%, to $84.5 million in the fiscal year
ended May 31, 1998 from $43.2 million in the fiscal year ended May 31, 1997.
The increase in our revenues reflected increases in both the size and number of
client projects. The Bentley Group acquisition contributed $16.4 million of
revenues in fiscal year 1998.
28
PROJECT PERSONNEL COSTS
Project personnel costs increased $22.1 million, or 131%, to $39.0 million in
fiscal 1998 from $16.9 million in fiscal 1997. The increase in project personnel
costs in fiscal 1998 was primarily due to an increase in engageable consultants,
as well as higher salaries. Project personnel costs as a percentage of revenues
increased to 46% in fiscal 1998 compared to 39% in fiscal 1997. This was due to
a substantial increase in our available engageable consultants who we were not
able to immediately deploy. The increase in available billable resources was
necessary to respond to the growing demand in our North American business.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses increased $16.1 million, or 84%, to
$35.4 million in fiscal 1998 from $19.4 million in fiscal 1997. Selling and
marketing expenses increased primarily as a result of our decision to expand our
sales and marketing effort in North America while general and administrative
support expenses increased due to the continued growth of eLoyalty.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses increased $0.7 million, or 41%, to
approximately $2.5 million in fiscal 1998 from $1.8 million in fiscal 1997.
Research and development expenses decreased as a percentage of total revenues to
3% in fiscal 1998 from 4% in fiscal 1997. This percentage decrease resulted from
our significant revenue growth in fiscal 1998 and the redeployment of our
development staff as engageable consultants to meet the demands of our expanding
North American business.
GOODWILL AMORTIZATION
Goodwill amortization expenses increased $2.8 million to $3.2 million in fiscal
1998 from $0.4 million in fiscal 1997. The increase in goodwill amortization was
primarily a result of The Bentley Group acquisition in June 1997.
NET (LOSS) INCOME
eLoyalty reported a net income of $2.2 million, or $0.05 per share on a diluted
basis, for fiscal year 1998 as compared with net income of $2.9 million, or
$0.06 per share on a diluted basis, for fiscal 1997.
LIQUIDITY AND CAPITAL RESOURCES
eLoyalty's principal capital requirements are to fund working capital needs,
capital expenditures and other investments in support of revenue generation
and growth. Since the spin-off and the associated cessation of operational
funding and cash management support from TSC, eLoyalty has been dependent on its
own ability to generate capital resources sufficient to meet its ongoing needs
for cash.
At December 30, 2000, eLoyalty had cash and cash equivalents of $41.1
million. Although this represented an increase of approximately $27.7 million in
cash and cash equivalents from December 31, 1999, the increase was attributable
entirely to the $68.3 million cash generated from financing activities, as
described below. Both operating activities and investing activities (in capital
expenditures) negatively impacted eLoyalty's available 2000 cash resources, with
a combined use of such cash resources aggregating nearly $41 million.
eLoyalty's operating activities used net cash of approximately $22.4
million during fiscal 2000 compared to $11.0 million during 1999. In addition to
the negative $0.4 million impact of its net loss for fiscal 2000 and increased
needs for cash due to its revenue growth, eLoyalty experienced a $32.9 million
(excluding currency effects), or 72%, increase in its net receivables balance
compared to that at the prior year-end. This increase is primarily due to the
increase in revenues of 50% in the fourth quarter of 2000.
Cash used by eLoyalty in investing activities consisted of capital
expenditures of $18.6 million during fiscal 2000 as compared to capital
expenditures of $2.2 million for 1999. The substantial increase in capital
expenditures for 2000 primarily related to eLoyalty's build-out of its own
infrastructure as a stand-alone company, including investments in computer
hardware and software, furniture, equipment and leasehold improvements for
separate facilities. eLoyalty expects that its capital expenditures for 2001
will be between $12 and $17 million.
29
eLoyalty has made an additional commitment to invest up to $14.7 million,
through another newly formed 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. eLoyalty has not yet 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.
Cash flows provided by financing activities increased $46.4 million to
$68.3 million for fiscal 2000 from $21.9 million in 1999. Cash from such
activities increased during fiscal 2000 primarily as a result of two financing
events: 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. Additional
cash flows from financing activities were provided by cash proceeds of $8.6
million from the exercise of employee stock options and purchases under
eLoyalty's employee stock purchase plan, and $4.8 million in net transfers from
TSC in connection with the spin-off, relating to the period from January 1, 2000
to its February 15, 2000 effective date.
eLoyalty's near-term capital resources consist of its current cash
balances, together with anticipated future cash flows from operations and
availability under an external credit line. eLoyalty's balance of cash and cash
equivalents was $41.1 million as of December 30, 2000.
eLoyalty has experienced delays during the first quarter of 2001 in closing
both new client engagements and extensions of existing engagements in its North
American operations. These delays are expected to contribute to an operating
loss and a net loss for the first quarter of 2001. Although eLoyalty does not
believe that these delays or the anticipated first quarter net loss is
indicative of a material adverse trend in its competitive position or
fundamental business, continuing net losses or adverse impacts on its accounts
receivable collection activities could require eLoyalty to accelerate use of its
existing cash balances to fund operations during 2001 and limit eLoyalty's
ability to fund discretionary capital and other expenditures. In response to
these economic uncertainties, eLoyalty is assessing various cost reduction
actions and on March 5, 2001 announced that it expected in its first quarter of
2001 to recognize a pre-tax charge of approximately $7 million, or $0.08 per
share on a diluted basis, related primarily to severance and associated costs.
eLoyalty entered into a business loan agreement with Bank of America, N.A.
(the "Bank"), effective as of December 30, 2000, providing for an unsecured
revolving line of credit in a maximum principal amount of $10 million through
December 30, 2001 (the "Facility"). The Facility in effect extended and
superseded eLoyalty's prior March 2000 revolving credit agreement with the Bank,
which had been guaranteed by TSC and expired on December 30, 2000. eLoyalty's
only borrowings under the prior line of credit related to letters of credit
required for operational commitments and aggregated $0.7 million at year-end
2000; this aggregate outstanding letter of credit amount was carried forward as
outstanding under the Facility. Loans under the Facility bear interest at the
Bank's prime rate or, at eLoyalty's election, an alternate rate of IBOR (an
offshore U.S. dollar interbank interest rate) plus 0.75%. Under the Facility,
eLoyalty agreed to pay a commitment fee of 0.125% of the unused portion of the
$10 million commitment and certain other loan fees and expenses.
The Facility requires eLoyalty to comply with various affirmative and
negative covenants, including ones relating to the maintenance of consolidated
tangible net worth of at least $70 million, limitations on other liabilities,
liens and investments and limitations on aggregate annual lease payments. In
addition, eLoyalty agreed to maintain unencumbered liquid assets with an
aggregate market value of from 100% to 150% (depending on the nature of such
assets and their location) of the total commitment. Accordingly, eLoyalty will
be required to maintain at least $10 million in liquid asset coverage throughout
2001 to be in compliance with these covenants and to have credit availability
under the Facility.
eLoyalty anticipates that its current cash resources, together with other
expected internal and external sources of liquidity, should be sufficient to
satisfy eLoyalty's working capital and capital expenditure needs for the balance
of the fiscal year. If, however, eLoyalty's operating activities or net cash
needs for the year were to differ
30
materially from current expectations, there could be no assurance, given current
capital market, credit and general economic uncertainties, that eLoyalty would
have access to additional external capital resources on acceptable terms.
QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
We provide our solutions to clients in a number of countries including the
United States, Canada, United Kingdom, Germany, France and Australia. For the
years ended December 2000 and 1999, 17% and 22%, 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. However, we believe that an increasing portion of our
revenues and costs will be denominated in foreign currencies in the future. As a
result of our exposure to foreign currencies, our future financial results
could be affected by factors such as changes in foreign currency exchange
rates or weak economic conditions in those foreign markets.
RECENT ACCOUNTING PRONOUNCEMENTS
On June 15, 1998, the Financial Accounting Standards Board (FASB) issued SFAS
No.133, "Accounting for Derivative Instruments and Hedging Activities." SFAS
No.133, as amended, is effective for fiscal years beginning after June 15, 2000
(2001 for eLoyalty). SFAS No. 133 requires that all derivative instruments be
recorded on the balance sheet as assets or liabilities at their fair value. It
also requires entities to reflect the gains or losses associated with changes
in the fair value of derivatives each period, either in current earnings or as a
separate component of other comprehensive income, depending on the nature of
the underlying contract or transaction. eLoyalty anticipates that the adoption
of SFAS No. 133 will not have a material effect on its results of operations,
financial position or cash flows.
Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial
Statements" (SAB 101), provides guidance in applying generally accepted
accounting principles to selected revenue recognition issues in financial
statements. On June 26, 2000, the SEC issued SAB 101B, an amendment to SAB 101
which delayed the implementation of SAB 101 until no later than the fourth
fiscal quarter of fiscal years beginning after December 15,1999. The
implementation of SAB 101 had no material effect on eLoyalty.
YEAR 2000 CONSIDERATIONS
eLoyalty knows of no significant Year 2000 related failures which have affected
eLoyalty-provided software or services or internal eLoyalty systems. Due to the
large number of software and systems solutions engagements eLoyalty has
undertaken over the years, there can be no assurance that all such software and
systems will be Year 2000 compliant or that eLoyalty may not be subject to
future claims as a result.
FACTORS THAT MAY AFFECT FUTURE RESULTS OR MARKET PRICE OF STOCK
Some of the factors that may affect eLoyalty's future results or the market
price of its stock and cause or contribute to material differences between
actual results and those reflected in forward-looking statements contained in
this report 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 major clients and suppliers, 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;
31
- 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 both firms with
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 tightening capital and credit markets to sufficient debt
and/or equity capital to meet eLoyalty's future operating and
financial needs;
- protection of eLoyalty's technology, proprietary information and
other intellectual property rights or challenges to eLoyalty's
intellectual property by third parties;
- future legislative or regulatory actions relating to the information
technology or information technology services industries;
- 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 generally; and
- the continued impact of the current economic slowdown, as well as
other future general business, capital market and economic conditions
and volatility.
32
RESPONSIBILITY FOR FINANCIAL STATEMENTS
The consolidated financial statements of eLoyalty Corporation have been prepared
by eLoyalty in conformity with generally accepted accounting principles.
Management is responsible for all information and representations contained in
the financial statements and other sections of the Annual Report. In preparing
the financial statements, management uses its judgment to make necessary
estimates.
Management maintains and relies on a system of internal controls in
fulfilling its financial reporting responsibilities. The system is designed to
provide reasonable assurance at a reasonable cost that assets are safeguarded
and transactions are executed in accordance with management's authorization and
recorded properly to permit the preparation of financial statements in
accordance with generally accepted accounting principles. The internal control
systems include written policies and procedures, an organizational structure
which provides for division of responsibilities and a development of qualified
managers in all areas. In addition, management continually monitors its internal
control systems in response to changes in business conditions and operations.
The Audit Committee of the Board of Directors, composed solely of directors
who are not officers or employees of eLoyalty Corporation, meets with corporate
financial management and the independent accountants to review their
activities and to satisfy itself that each is properly discharging its
responsibility. The independent accountants have met periodically with the
Committee, without the presence of management, to discuss the results of their
audit work, the adequacy of internal financial controls and the quality of
financial reporting.
/s/ Kelly D. Conway /s/ Timothy J. Cunningham
------------------- -------------------------
Kelly D. Conway Timothy J. Cunningham
President and Chief Executive Officer Senior Vice President,
Chief Financial Officer and
Corporate Secretary
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 and comprehensive income (loss) present fairly, in all
material respects, the financial position of eLoyalty Corporation and
subsidiaries (the "Company") as of December 30, 2000 and December 31, 1999, and
the results of their operations and their cash flows for the years ended
December 30, 2000 and December 31, 1999, for the seven month period from June 1,
1998 to December 31, 1998 and for the year ended May 31, 1998, in conformity
with accounting principles generally accepted in the United States of America.
These financial statements are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements 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.
/s/ PricewaterhouseCoopers LLP
------------------------------
PricewaterhouseCoopers LLP
Chicago, Illinois
January 30, 2001
33
CONSOLIDATED BALANCE SHEETS
eLoyalty Corporation
[Enlarge/Download Table]
ASSETS
DECEMBER 30, DECEMBER 31,
(In thousands, except share and per share data) 2000 1999
------------------------------------------------------------------------------------------------------------------
Current Assets:
Cash and cash equivalents $ 41,138 $ 13,462
Marketable securities 9,902 7,175
Receivables, net 75,886 44,056
Deferred income taxes 16,301 9,057
Prepaid expenses 2,935 3,093
Other current assets 7,534 1,072
--------- ---------
Total current assets 153,696 77,915
Equipment and leasehold improvements, net 18,784 2,284
Goodwill, net 6,990 12,129
Deferred income taxes 2,664 2,387
Long-term receivables and other 2,484 1,888
--------- ---------
Total assets $ 184,618 $ 96,603
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 6,880 $ 640
Accrued compensation and related costs 19,964 11,687
Deferred compensation 9,897 7,175
Other current liabilities 7,021 3,486
--------- ---------
Total current liabilities 43,762 22,988
--------- ---------
Commitments and contingencies -- --
Stockholders' Equity:
Preferred stock, $.01 par value; 10,000,000 shares
authorized; none issued and outstanding -- --
Common stock, $.01 par value; 100,000,000 shares authorized;
49,925,702 and 41,400,000 shares issued and outstanding, respectively 499 414
Additional paid-in capital 144,860 963
Net advances from Technology Solutions Company -- 74,048
Retained earnings 2,171 --
Accumulated other comprehensive loss (1,970) (847)
Unearned compensation (4,704) (963)
--------- ---------
Total stockholders' equity 140,856 73,615
--------- ---------
Total liabilities and stockholders' equity $ 184,618 $ 96,603
--------- ---------
The accompanying Notes to Consolidated Financial Statements are an integral part
of this financial information.
34
CONSOLIDATED STATEMENTS OF OPERATIONS
eLoyalty Corporation
[Enlarge/Download Table]
FOR THE SEVEN MONTH FOR THE FISCAL
FOR THE YEARS PERIOD FROM JUNE 1 TO YEAR ENDED
ENDED DECEMBER DECEMBER 31, MAY 31,
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2000 1999 1998 1998
---------------------------------------------------------------------------------------------------------------------------
Revenues $ 211,603 $ 146,003 $ 64,415 $ 84,488
Project personnel costs 104,203 68,483 29,562 39,049
--------- --------- --------- ---------
Gross profit 107,400 77,520 34,853 45,439
--------- --------- --------- ---------
Other costs and expenses:
Selling, general and administrative 96,875 58,395 29,132 35,436
Research and development 9,322 5,624 3,089 2,543
Goodwill amortization 4,972 4,996 2,450 3,201
--------- --------- --------- ---------
Total other expenses 111,169 69,015 34,671 41,180
--------- --------- --------- ---------
Operating (loss) income (3,769) 8,505 182 4,259
--------- --------- --------- ---------
Other income (loss) 2,921 (408) (327) (24)
--------- --------- --------- ---------
(Loss) income before income taxes (848) 8,097 (145) 4,235
Income tax (benefit) provision (424) 4,039 398 2,022
--------- --------- --------- ---------
Net (loss) income $ (424) $ 4,058 $ (543) $ 2,213
========= ========= ========= =========
Basic net (loss) income per common share $ (0.01) $ 0.10 $ (0.01) $ 0.05
Diluted net (loss) income per common share $ (0.01) $ 0.09 $ (0.01) $ 0.05
Shares used to calculate basic net
(loss) income per share (in millions) 48.2 41.4 41.4 41.4
========= ========= ========= =========
Shares used to calculate diluted
net (loss) income per share (in millions) 48.2 44.2 41.4 46.8
========= ========= ========= =========
The accompanying Notes to Consolidated Financial Statements are an integral part
of this financial information.
35
CONSOLIDATED STATEMENTS OF CASH FLOWS
eLoyalty Corporation
[Enlarge/Download Table]
FOR THE SEVEN MONTH FOR THE FISCAL
FOR THE YEARS PERIOD FROM JUNE 1 TO YEAR ENDED
ENDED DECEMBER DECEMBER 31, MAY 31,
(IN THOUSANDS) 2000 1999 1998 1998
---------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income $ (424) $ 4,058 $ (543) $ 2,213
Adjustments to reconcile net (loss) income
to net cash (used in) provided by
operating activities:
Depreciation and amortization 7,549 6,355 3,509 3,874
Provisions for doubtful receivables 4,064 2,059 2,652 531
Deferred income taxes (7,950) (5,763) (3,432) (2,118)
Other -- 463 412 --
Changes in assets and liabilities:
Receivables (36,932) (21,496) (4,197) (10,217)
Purchases of trading securities related to
deferred compensation program (2,727) (2,689) (830) (2,096)
Other current assets (6,407) (1,038) 278 (1,079)
Accounts payable 6,281 (313) 647 (1,184)
Accrued compensation and related costs 8,565 4,517 776 2,674
Deferred compensation funds from employees 2,722 2,689 830 2,096
Other current liabilities 3,523 653 538 (2,383)
Other long-term assets (613) (536) (11) (815)
-------- -------- -------- --------
Net cash (used in) provided by
operating activities (22,349) (11,041) 629 (8,504)
-------- -------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (18,633) (2,175) (570) (1,065)
Investment in unconsolidated investee -- -- (875) --
Acquired businesses -- -- (6,625) (10,741)
-------- -------- -------- --------
Net cash used in investing activities (18,633) (2,175) (8,070) (11,806)
-------- -------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 34,914 -- -- --
Proceeds from stock compensation plans 8,552 -- -- --
Capital contribution from Technology
Solutions Company 20,000 -- -- --
Net advances from Technology Solutions Company 4,802 21,929 7,777 21,608
-------- -------- -------- --------
Net cash provided by financing activities 68,268 21,929 7,777 21,608
-------- -------- -------- --------
Effect of exchange rate changes on cash
and cash equivalents 390 338 (651) (702)
-------- -------- -------- --------
Increase (decrease) in cash and cash equivalents 27,676 9,051 (315) 596
Cash and cash equivalents, beginning of period 13,462 4,411 4,726 4,130
-------- -------- -------- --------
Cash and cash equivalents, end of period $ 41,138 $ 13,462 $ 4,411 $ 4,726
======== ======== ======== ========
The accompanying Notes to Consolidated Financial Statements are an integral part
of this financial information.
36
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS'
EQUITY AND COMPREHENSIVE INCOME (LOSS)
eLoyalty Corporation
[Enlarge/Download Table]
ADVANCES
from ACCUMULATED
COMMON STOCK ADDITIONAL TECHNOLOGY OTHER TOTAL
(In thousands, ------------------- PAID-IN SOLUTIONS RETAINED COMPREHENSIVE UNEARNED STOCKHOLDERS'
except share data) SHARES AMOUNT CAPITAL COMPANY EARNINGS INCOME (LOSS) COMPENSATION EQUITY
-----------------------------------------------------------------------------------------------------------------------------------
Balance, May 31, 1997 -- $ -- $ -- $ 17,420 $ -- $ (273) $ -- $ 17,147
---------- ---- -------- -------- ------ ------- ------- --------
Net income 2,213 2,213
Foreign currency translation (75) (75)
--------
Comprehensive income 2,138
Net transfers from TSC 21,608 21,608
---------- ---- -------- -------- ------ ------- ------- --------
Balance, May 31, 1998 -- -- -- 41,241 -- (348) -- 40,893
---------- ---- -------- -------- ------ ------- ------- --------
Net loss (543) (543)
Foreign currency translation (239) (239)
--------
Comprehensive loss (782)
Net transfers from TSC 7,777 7,777
---------- ---- -------- -------- ------ ------- ------- --------
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
pursuant to stock-based awards 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
========== ==== ======== ======== ====== ======= ======= ========
The accompanying Notes to Consolidated Financial Statements are an integral part
of this financial information.
37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
eLoyalty Corporation
(IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE ONE--DESCRIPTION OF BUSINESS
eLoyalty is a global management consulting and systems integration organization
focused exclusively on building customer loyalty. eLoyalty has 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.
Certain reclassifications have been made to the 1999 and 1998 statements of
operations to conform to the 2000 presentation.
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 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. The
seven month period of June 1, 1998 through December 31, 1998 preceded the start
of the new December 31 fiscal 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 costs incurred to
total estimated costs. 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
38
are included in project personnel costs as incurred. Out-of-pocket expenses
(travel, lodging, etc.) charged on client engagements are presented net of
amounts billed to clients as general and administrative expense in the
statements of operations. Losses on engagements, if any, are recognized when
determined. eLoyalty also derives revenues from in-house developed 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 generally 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.
Project Personnel Costs--eLoyalty expenses the cost of project personnel as
incurred. Project personnel costs consist primarily of salaries, incentive
compensation and 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 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.
Marketable Securities--eLoyalty's marketable securities consist of
investments related to eLoyalty's executive deferred compensation plan (see
Note Nine) 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 $89 for the year ended December 30, 2000 and net gains of $730,
$167 and $823 for the year ended December 31, 1999, the seven month period ended
December 31, 1998 and the fiscal year ended May 31, 1998, respectively. 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.
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 moved
from the account 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.
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 in the development phase are capitalized and amortized over the asset's
estimated useful life, generally three to five years.
Goodwill--Goodwill is amortized on a straight-line basis, generally over a
five-year period. Accumulated amortization of goodwill as of December 30, 2000
and December 31, 1999 was $16,477 and $11,518, respectively. The carrying value
of goodwill is periodically reviewed to assess recoverability based on future
undiscounted cash flows.
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
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
39
eLoyalty's balance sheets as of December 30, 2000 and December 31, 1999.
Amortization expense associated with software development costs was $447 and
$354 for the seven month period ended December 31, 1998 and the fiscal year
ended May 31, 1998, respectively. There was no amortization expense of software
development costs during the year ended December 30, 2000 or December 31, 1999.
Stockholders' Equity--Stockholders' equity includes common stock issued,
retained earnings, accumulated other comprehensive income (loss) related to
foreign currency translation and unearned compensation related to stock-based
compensation. Net advances 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
advances from TSC were recorded as common stock and additional paid-in capital
(see Note Three). Following the spin-off, eLoyalty no longer received
operational funding from TSC and no longer participated in the TSC cash
management program.
Earnings (Loss) Per Common Share--eLoyalty calculates earnings (loss) per
share in accordance with SFAS No. 128. 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 has 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 U.S. dollars at end of period exchange
rates. The resulting translation adjustments are recorded as a component of
stockholders' equity. 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 statements of
operations.
Fair Value of Financial Instruments--The carrying values of current assets
and liabilities and long-term receivables approximated their fair values as of
December 30, 2000 and December 31, 1999.
Concentration of Credit Risk--eLoyalty had one client, Agilent
Technologies, Inc., accounting 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, the seven month period ended December 31, 1998 or the year
ended May 31, 1998. No client accounted for 10% or more of accounts receivables
as of December 30, 2000 or December 31, 1999.
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 is 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 stock options. The unearned
compensation recorded at 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 U.S. 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.
40
New Accounting Standards--On June 15, 1998, the Financial Accounting
Standards Board (FASB) issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133, as amended, is effective for
fiscal years beginning after June 15, 2000 (2001 for eLoyalty). SFAS No. 133
requires that all derivative instruments be recorded on the balance sheet at
their fair value. Changes in the fair value of derivatives are recorded each
period in current earnings or other comprehensive income, depending on whether a
derivative is designated as part of a hedge transaction and, if it is, the type
of hedge transaction. eLoyalty anticipates that the adoption of SFAS No. 133
will not have a significant effect on eLoyalty's results of operations, cash
flows or financial position.
Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial
Statements" (SAB 101), provides guidance in applying generally accepted
accounting principles to selected revenue recognition issues in financial
statements. On June 26, 2000, the SEC issued SAB 101B, an amendment to SAB 101,
which delayed the implementation of SAB 101 until no later than the fourth
fiscal quarter of fiscal years beginning after December 15, 1999. The
implementation of SAB 101 had no material effect on eLoyalty.
NOTE THREE--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:
[Download Table]
(In 000's) 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 FOUR--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, the seven month period ended
December 31, 1998 and the fiscal year ended May 31, 1998 were $5,036, $14,173,
$8,429 and $11,643 respectively.
eLoyalty periodically provides employee loans as part of employment
agreements. These loans have interest rates ranging from 4.5% to 7.5%. 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 $3.4 million and
$2.1 million, respectively, as of December 30, 2000 and December 31, 1999.
41
NOTE FIVE--RECEIVABLES
Receivables consist of the following:
[Download Table]
AS OF DECEMBER
------------------------------
2000 1999
------------------------------------------------------------------------------
Amounts billed to clients $ 62,501 $ 39,552
Unbilled revenues 14,990 6,588
-------- --------
77,491 46,140
Receivable allowances (1,605) (2,084)
-------- --------
Receivables $ 75,886 $ 44,056
======== ========
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 amount of unbilled
revenues at the end of any reporting period is billed in the month following the
reporting period. Amounts billed to clients are unsecured and primarily due
within 30 days.
NOTE SIX--EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment and leasehold improvements consist of the following:
[Download Table]
AS OF DECEMBER
------------------------------
2000 1999
------------------------------------------------------------------------------
Computers and software $ 15,840 $ 3,636
Furniture and equipment 4,750 1,006
Leasehold improvements 3,338 729
-------- --------
23,928 5,371
Accumulated depreciation and amortization (5,144) (3,087)
-------- --------
Equipment and leasehold improvements $ 18,784 $ 2,284
======== ========
Depreciation expense was $2,057, $1,502, $421 and $308 for the years ended
December 30, 2000 and December 31, 1999, the seven month period ended
December 31, 1998 and the fiscal year ended May 31, 1998, respectively.
NOTE SEVEN--INCOME TAXES
The income tax (benefit) provision consists of the following:
[Enlarge/Download Table]
FOR THE SEVEN MONTH
FOR THE YEAR ENDED FOR THE YEAR ENDED PERIOD FROM JUNE 1 FOR THE YEAR ENDED
DECEMBER 30, DECEMBER 31, TO DECEMBER 31, MAY 31,
2000 1999 1998 1998
-------------------------------------------------------------------------------------------------------------
Current:
Federal $ 6,950 $ 4,546 $(1,929) $ 115
State 859 1,059 (275) 16
Foreign (712) 1,876 (830) (227)
------- ------- ------- -------
Total current 7,097 7,481 (3,034) (96)
------- ------- ------- -------
Deferred:
Federal (1,923) (2,008) 1,941 1,357
State 204 (478) 277 194
Foreign (5,802) (956) 1,214 567
------- ------- ------- -------
Total deferred (7,521) (3,442) 3,432 2,118
------- ------- ------- -------
Income tax (benefit) provision $ (424) $ 4,039 $ 398 $ 2,022
======= ======= ======= =======
42
Total income tax (benefit) provision differed from the amount computed by
applying the federal statutory income tax rate due to the following:
[Enlarge/Download Table]
FOR THE SEVEN MONTH
FOR THE YEAR ENDED FOR THE YEAR ENDED PERIOD FROM JUNE 1 FOR THE YEAR ENDED
DECEMBER 30, DECEMBER 31, TO DECEMBER 31, MAY 31,
2000 1999 1998 1998
-----------------------------------------------------------------------------------------------------------------------
Federal tax provision
(benefit), at statutory rate $ (297) $ 2,834 $ (50) $ 1,475
State tax provision (benefit),
net of Federal benefit 539 405 (6) 211
Effect of foreign tax rate
differences (1,205) 406 303 34
Nondeductible expenses 208 134 61 96
Nondeductible goodwill 235 279 170 172
Other 96 (19) (80) 34
------- ------- ------- -------
Income tax (benefit) provision $ (424) $ 4,039 $ 398 $ 2,022
======= ======= ======= =======
Deferred tax assets and liabilities were comprised of the following:
[Download Table]
AS OF DECEMBER
---------------------------
2000 1999
----------------------------------------------------------------------------------
Deferred tax assets:
Deferred compensation and bonuses $ 3,753 $ 2,870
Equity losses of unconsolidated investee 341 341
Receivable allowances 448 918
Other accruals 2,061 936
Net operating loss carryforwards 10,798 4,996
Depreciation and amortization 2,680 2,387
-------- --------
Total deferred tax assets 20,081 12,448
-------- --------
Deferred tax liabilities:
Prepaid expenses (1,116) (1,004)
-------- --------
Total deferred tax liabilities (1,116) (1,004)
-------- --------
Net deferred tax asset $ 18,965 $ 11,444
======== ========
Net operating loss carryforwards relate primarily to eLoyalty's UK
operations and have an indefinite carryforward period. 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
Twelve). 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:
[Enlarge/Download Table]
FOR THE SEVEN MONTH
FOR THE YEAR ENDED FOR THE YEAR ENDED PERIOD FROM JUNE 1 FOR THE YEAR ENDED
DECEMBER 30, DECEMBER 31, TO DECEMBER 31, MAY 31,
2000 1999 1998 1998
------------------------------------------------------------------------------------------------------------
United States $ 18,602 $ 7,447 $ (164) $ 3,781
Foreign (19,450) 650 19 454
-------- -------- -------- --------
Total $ (848) $ 8,097 $ (145) $ 4,235
======== ======== ======== ========
43
NOTE EIGHT--LINE OF CREDIT
eLoyalty entered into a business loan agreement with Bank of America, N.A. (the
"Bank") effective as of December 30, 2000, providing for an unsecured revolving
line of credit in a maximum principal amount of $10 million through December 30,
2001 (the "Facility"). The Facility in effect extended and superseded eLoyalty's
prior March 2000 revolving credit agreement with the Bank, which had been
guaranteed by TSC and expired on December 30, 2000. eLoyalty's only borrowings
under the prior line of credit related to letters of credit required for
operational commitments and aggregated $0.7 million at year-end 2000; this
aggregate outstanding letter of credit amount was carried forward as outstanding
under the Facility. Loans under the Facility bear interest at the Bank's prime
rate or, at eLoyalty's election, an alternate rate of IBOR (an offshore U.S.
dollar interbank interest rate) plus 0.75%. Under the Facility, eLoyalty agreed
to pay a commitment fee of 0.125% of the unused portion of the $10 million
commitment and certain other loan fees and expenses.
The Facility requires eLoyalty to comply with various affirmative and
negative covenants, including ones relating to the maintenance of consolidated
tangible net worth of at least $70 million, limitations on other liabilities,
liens and investments and limitations on aggregate annual lease payments. In
addition, eLoyalty agreed to maintain unencumbered liquid assets with an
aggregate market value of from 100% to 150% (depending on the nature of such
assets and their location) of the total commitment. Accordingly, eLoyalty will
be required to maintain at least $10 million in liquid asset coverage throughout
2001 to be in compliance with these covenants and to have credit availability
under the Facility.
NOTE NINE--EXECUTIVE DEFERRED COMPENSATION PLAN
All eLoyalty executives (defined for this purpose as Vice Presidents and above)
are eligible to participate in the eLoyalty Executive Deferred Compensation Plan
(the "EDCP"). The EDCP is a nonqualified deferred compensation plan that permits
participants to elect to defer receipt of a portion of their compensation.
Deferred contributions and investment earnings are payable to participants upon
various specified events, including retirement, disability or termination. The
accompanying consolidated balance sheets include the deferred compensation
liability, including investment earnings thereon, owed to participants. The
accompanying consolidated balance sheets also include the investments,
classified as trading securities, purchased by eLoyalty with the deferred funds.
These investments remain assets of eLoyalty and are available to the general
creditors of eLoyalty in the event of eLoyalty's insolvency. Prior to the
spin-off from TSC, eLoyalty executives participated in the TSC non-qualified
executive deferred compensation plan.
NOTE TEN--EMPLOYEE BENEFIT PLANS
eLoyalty 401(k) Savings Plan--eLoyalty employees are eligible to participate in
the eLoyalty Corporation 401(k) Savings 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.
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
$1,697 and $1,131 for the years ended December 30, 2000 and December 31, 1999,
$487 for the seven month period ended December 31, 1998 and $470 in the fiscal
year ended May 31, 1998.
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
500,000 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
250,281 shares of eLoyalty common stock for the year ended December 30, 2000.
44
NOTE ELEVEN--CAPITAL STOCK
eLoyalty was spun off from TSC into a separately, publicly traded company on
February 15, 2000. In connection with establishing eLoyalty as a separate
entity, 100,000,000 shares of common stock, $0.01 par value, were authorized, of
which 43,929,029 common stock shares were issued. eLoyalty also has authorized
10,000,000 shares of preferred stock, $0.01 par value, of which none has been
issued.
Pursuant to the spin-off, eLoyalty also received $8.4 million from the sale
of 2.5 million shares of common stock to Technology Crossover Ventures (TCV) and
Sutter Hill Ventures. On May 26, 2000, eLoyalty also closed its common stock
purchase agreement with TCV entities and issued 2 million shares 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 $26.5 million, 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, each share of eLoyalty's common stock
has associated with it one Right. 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 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.
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 at the exercise price (or if eLoyalty is acquired in a
merger or other business combination, common stock of the acquiror) 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 TWELVE--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").
Under the 1999 Plan, awards of stock options, stock appreciation rights,
bonus and restricted stock and performance share 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 or restricted
stock. An aggregate of 5,340,000 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, 7,387,561 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 2000 Plan, non-statutory stock option
awards may be granted to officers, employees and certain consultants and
independent contractors of eLoyalty and its subsidiaries. An aggregate of
2,800,000 shares of eLoyalty common stock has been reserved for issuance under
the 2000 Plan.
45
If options or shares awarded under the 1999 Plan and the 2000 Plan are not
issued due to forfeiture or other reason, then those options or shares will
again become available for issuance under the plans. As of December 30, 2000,
there were a total of 1,419,742 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 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 50,000 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 12,000 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. The substitute
option will take 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 7,387,561 substitute option shares
issued in connection with the spin-off, 3,557,823 were issued to persons who
were employees or directors of eLoyalty immediately after the spin-off.
Under the 1999 Stock Incentive Plan, eLoyalty granted 293,125 shares of
restricted stock to certain executives during the year ending December 30,
2000. During the restricted period, the holders of such shares have the same
rights as stockholders of eLoyalty, except that the shares may not be sold,
assigned, pledged or otherwise encumbered. Restrictions on such shares lapse
ratably over a period of 60 months. As of December 30, 2000, a total of
268,670 shares continued to be subject to restrictions.
46
Option activity was as follows for the years ending December 31, 1999 and
December 30, 2000:
[Enlarge/Download Table]
OPTION WEIGHTED-AVERAGE OPTIONS
SHARES EXERCISE PRICE EXERCISABLE
--------------------------------------------------------------------------------------------------------------
Outstanding as of December 31, 1998 -- -- --
Granted 5,447,250 $ 3.88
Exercised -- --
Forfeited (107,250) $ 3.50
----------- ------ -----------
Outstanding as of December 31, 1999 5,340,000 $ 3.89 --
Granted 5,066,914 $20.91
Granted in connection with the spin-off(1) 7,387,561 $ 6.85
Exercised (913,287) $ 6.24
Forfeited (1,908,386) $18.65
----------- ------ -----------
Outstanding as of December 30, 2000 14,972,802 $ 9.09 5,941,429
=========== ====== ===========
(1) Includes options issued in connection with the spin-off in substitution of
previously granted TSC options.
The following table summarizes the status of stock options outstanding and
exercisable as of December 30, 2000 by range of exercise price:
[Enlarge/Download Table]
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------------------- ------------------------
RANGE OF WEIGHTED-AVERAGE WEIGHTED-AVERAGE EXERCISE
NUMBER NUMBER REMAINING CONTRACTUAL EXERCISE PRICE NUMBER PRICE PER
EXERCISE PRICES OUTSTANDING LIFE (IN YEARS) PER SHARE EXERCISABLE SHARE
--------------------------------------------------------------------------------------------------------
$ 0.27-$ 4.99 6,772,844 8.7 $ 3.04 2,335,432 $ 2.15
$ 5.00-$ 9.99 3,437,144 7.7 $ 7.88 2,342,282 $ 7.96
$10.00-$14.99 3,306,278 9.0 $ 13.51 760,184 $ 13.31
$15.00-$24.99 541,252 8.8 $ 18.96 326,824 $ 18.37
$25.00-$36.63 915,284 9.1 $ 36.60 176,707 $ 36.60
---------- --- ------- --------- -------
Total 14,972,802 8.6 $ 9.09 5,941,429 $ 7.79
========== === ======= ========= =======
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 is measured as
the excess, if any, of the fair value of eLoyalty 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 112,000 shares at a lower exercise price. The cancellation
and reissuance of these shares 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 2000 based on the fair value of eLoyalty's common stock
during 2000. In addition, options for 586,250 shares were cancelled and replaced
through the issuance of the restricted common stock discussed above. Under APB
No. 25, the fair value of restricted shares at the date of grant is amortized to
expense ratably over the restriction period. eLoyalty recorded compensation
expense related to stock-based awards of approximately $520,000 for the year
ended December 30, 2000.
47
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. The weighted average grant date fair value
and the assumptions used in the Black-Scholes model to calculate such fair
values are shown below:
[Enlarge/Download Table]
FOR THE SEVEN MONTH
FOR THE YEAR ENDED FOR THE YEAR ENDED PERIOD ENDED FOR THE YEAR ENDED
DECEMBER 30, DECEMBER 31, DECEMBER 31, MAY 31,
OPTIONS 2000 1999 1998 1998
------------------------------------------------------------------------------------------------------------------------------
Substitute TSC Options(1)
Expected volatility -- 49.7%-54.2% 43.6%-49.8% 41.9%-44.1%
Risk-free interest rates -- 4.6%-6.3% 4.1%-5.6% 5.3%-6.5%
Expected lives -- 4.5 years 4.5 years 4.5 years
Dividends -- -- -- --
Weighted average grant date fair value -- $ 5.08 $ 8.15 $ 7.90
eLoyalty Options
Expected volatility 50% 50%
Risk-free interest rates 5.6%-6.8% 5.7%-6.3%
Expected lives 4.5 years 4.5 years
Dividends -- --
Weighted average grant date fair value
Issued above market prices $ 12.62 --
Issued at market prices $ 5.31 $ 1.79
Issued below market prices $ 8.54 $ 8.62
(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 No. 123, eLoyalty's net (loss) income and
earnings (loss) per share would have been reduced to the pro forma amounts
indicated below:
[Enlarge/Download Table]
FOR THE SEVEN MONTH
FOR THE YEAR ENDED FOR THE YEAR ENDED PERIOD ENDED FOR THE YEAR ENDED
DECEMBER 30, DECEMBER 31, DECEMBER 31, MAY 31,
2000 1999 1998 1998
-------------------------------------------------------------------------------------------------------------------
Net (loss) income:
As reported $ (424) $4,058 $ (543) $2,213
Pro forma $(12,381) $1,219 $(2,574) $ (500)
Basic net (loss) income per share:
As reported $ (0.01) $ 0.10 $ (0.01) $ 0.05
Pro forma $ (0.26) $ 0.03 $ (0.06) $(0.01)
Diluted net (loss) income per share:
As reported $ (0.01) $ 0.09 $ (0.01) $ 0.05
Pro forma $ (0.26) $ 0.03 $ (0.06) $(0.01)
48
NOTE THIRTEEN--EARNINGS PER SHARE
The following table sets forth the computation of the shares used in the
calculation of basic and diluted earnings per share:
[Enlarge/Download Table]
FOR THE SEVEN MONTH FOR THE FISCAL
FOR THE YEARS ENDED PERIOD FROM JUNE 1 YEAR ENDED
DECEMBER TO DECEMBER 31, MAY 31,
2000 1999 1998 1998
-----------------------------------------------------------------------------------------------------------------
Weighted average shares outstanding 48,231 41,400 41,400 41,400
Common stock equivalents(1) 5,491 2,800 NA (2) 5,400
------ ------ ------ ------
Total weighted average shares and
common stock equivalents 53,722 44,200 41,400 46,800
====== ====== ====== ======
(1) In December 1999 eLoyalty issued 41.4 million shares to TSC. For periods
prior to February 15, 2000 the weighted average shares outstanding is based
on the 41.4 million shares.
(2) 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.
NOTE FOURTEEN--SEGMENT INFORMATION
eLoyalty operates as a single reportable segment. The following is revenue and
long-lived asset information by geographic area as of and for the years ended
December 30, 2000 and December 31, 1999, the seven month period ended December
31, 1998 and the fiscal year ended May 31, 1998.
[Enlarge/Download Table]
UNITED EUROPE AND
FOR THE YEAR ENDED DECEMBER 30, 2000 STATES CANADA AUSTRALIA TOTAL
---------------------------------------------------------------------------------------------------
Revenues $176,012 $ 9,432 $ 26,159 $211,603
Identifiable Assets $147,219 $ 6,616 $ 30,783 $184,618
UNITED EUROPE AND
For the Year Ended December 31, 1999 STATES CANADA AUSTRALIA TOTAL
---------------------------------------------------------------------------------------------------
Revenues $113,504 $ 7,577 $ 24,922 $146,003
Identifiable Assets $ 63,770 $ 3,874 $ 28,959 $ 96,603
For the Seven Month Period UNITED EUROPE AND
Ended December 31, 1998 STATES CANADA AUSTRALIA TOTAL
---------------------------------------------------------------------------------------------------
Revenues $50,139 $ 3,729 $10,547 $64,415
Identifiable Assets $42,715 $ 3,300 $17,889 $63,904
UNITED EUROPE AND
For the Year Ended May 31, 1998 STATES CANADA AUSTRALIA TOTAL
---------------------------------------------------------------------------------------------------
Revenues $61,882 $ 6,296 $16,310 $84,488
Identifiable Assets $34,711 $ 3,008 $16,399 $54,118
NOTE FIFTEEN--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 $6,659, $1,436, $469
and $738 for the years ended December 30, 2000 and December 31, 1999, the seven
month period ended December 31, 1998 and for the fiscal year ended May 31, 1998,
respectively. Future minimum rental commitments under noncancelable operating
leases with terms in excess of one year are as follows:
[Download Table]
YEAR AMOUNT
2001 $ 6,804
2002 5,976
2003 3,570
2004 2,720
2005 1,622
Thereafter 756
-------
$21,448
=======
49
NOTE SIXTEEN--QUARTERLY DATA (UNAUDITED)
[Enlarge/Download Table]
(In thousands, except per share data) 1st 2nd 3rd 4th Year
------------------------------------------------------------------------------------------------------------------
For the Year Ended December 2000
Revenues $ 46,179 $ 50,960 $ 56,818 $ 57,646 $ 211,603
Gross profit $ 24,998 $ 26,052 $ 28,171 $ 28,179 $ 107,400
Net (loss) income $ 156 $ 406 $ 348 $ (1,334)(1) $ (424)
Basic net (loss) income per share $ 0.00 $ 0.01 $ 0.01 $ (0.03) $ (0.01)
Diluted net (loss) income per share $ 0.00 $ 0.01 $ 0.01 $ (0.03) $ (0.01)
Shares used to calculate basic
net (loss) income per share
(in millions) 44.3 47.9 49.7 49.8 48.2
Shares used to calculate diluted
net (loss) income per share
(in millions) 49.9 53.1 54.4 49.8 48.2
For the Year Ended December 1999
Revenues $ 31,491 $ 36,145 $ 40,016 $ 38,351 $ 146,003
Gross profit $ 17,430 $ 19,191 $ 21,355 $ 19,544 $ 77,520
Net (loss) income $ 727 $ 1,480 $ 1,879 $ (28) $ 4,058
Basic net (loss) income per share $ 0.02 $ 0.04 $ 0.05 $ (0.01) $ 0.10
Diluted net (loss) income per share $ 0.02 $ 0.03 $ 0.04 $ (0.01) $ 0.09
Shares used to calculate basic
net (loss) income per share
(in millions) 41.4 41.4 41.4 41.4 41.4
Shares used to calculate diluted
net (loss) income per share
(in millions) 42.4 42.4 44.6 41.4 44.2
(1) The fourth quarter of 2000 includes a $2.8 million incremental charge for
uncollectable amounts due from clients.
50
Dates Referenced Herein and Documents Incorporated by Reference
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