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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-27975
ELOYALTY CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
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<S> <C>
DELAWARE 36-4304577
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
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150 FIELD DRIVE
SUITE 250
LAKE FOREST, ILLINOIS 60045
(847) 582-7000
(Address, Including Zip Code, and Telephone Number, Including Area Code, of
Registrant's Principal Executive Offices)
------------------------
INDICATE BY CHECK MARK WHETHER THE REGISTRANT: (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR SECTION 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES [X] NO [ ]
THE NUMBER OF OUTSTANDING SHARES OF THE REGISTRANT'S COMMON STOCK, $0.01
PAR VALUE PER SHARE, AS OF AUGUST 7, 2000 WAS 49,359,440.
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TABLE OF CONTENTS
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PAGE
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.............................. 1
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................... 6
Item 3. Quantitative and Qualitative Disclosures About
Market Risk............................................ 12
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds......... 13
Item 6. Exhibits and Reports on Form 8-K.................. 13
Signatures................................................ 14
Exhibit Index............................................. 15
</TABLE>
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ELOYALTY CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
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<CAPTION>
JUNE 30, DECEMBER 31,
2000 1999
-------- ------------
(UNAUDITED)
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ASSETS:
CURRENT ASSETS:
Cash and cash equivalents................................... $ 73,470 $13,462
Marketable securities....................................... 9,260 7,175
Receivables (less allowances of $2,043 and $2,084,
respectively)............................................. 51,692 44,056
Deferred income taxes....................................... 13,301 9,057
Prepaid expenses............................................ 3,993 3,093
Other current assets........................................ 1,355 1,072
-------- -------
Total current assets................................... 153,071 77,915
COMPUTERS, FURNITURE AND EQUIPMENT, NET..................... 7,443 2,284
GOODWILL, NET............................................... 9,623 12,129
DEFERRED INCOME TAXES....................................... 2,911 2,387
LONG-TERM RECEIVABLES AND OTHER............................. 2,627 1,888
-------- -------
Total assets........................................... $175,675 $96,603
======== =======
LIABILITIES & STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable............................................ $ 5,359 $ 640
Accrued compensation and related costs...................... 16,275 11,687
Deferred compensation....................................... 9,260 7,175
Other current liabilities................................... 7,374 3,486
-------- -------
Total current liabilities.............................. 38,268 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;
Issued and outstanding 49,262,729 shares and 41,400,000
shares, respectively...................................... 493 414
Additional paid-in capital.................................. 138,508 963
Net advances from Technology Solutions Company.............. -- 74,048
Retained earnings........................................... 3,157 --
Other....................................................... (4,751) (1,810)
-------- -------
Total stockholders' equity............................. 137,407 73,615
-------- -------
Total liabilities and stockholders' equity............. $175,675 $96,603
======== =======
</TABLE>
The accompanying Notes to Condensed Consolidated Financial Statements
are an integral part of this financial information.
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ELOYALTY CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
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FOR THE FOR THE
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ ------------------
2000 1999 2000 1999
---- ---- ---- ----
(UNAUDITED) (UNAUDITED)
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REVENUES................................................ $50,960 $36,145 $97,139 $67,636
Project personnel..................................... 24,908 16,954 46,089 31,015
------- ------- ------- -------
GROSS PROFIT............................................ 26,052 19,191 51,050 36,621
------- ------- ------- -------
OTHER COSTS AND EXPENSES:
Selling, general and administrative................... 20,712 10,125 40,360 20,365
Research and development.............................. 2,300 1,331 4,328 2,507
Technology Solutions Company corporate services
expense............................................ 1,800 3,555 4,010 6,706
Goodwill amortization................................. 1,242 1,249 2,488 2,501
------- ------- ------- -------
26,054 16,260 51,186 32,079
------- ------- ------- -------
OPERATING INCOME (LOSS)................................. (2) 2,931 (136) 4,542
OTHER INCOME (EXPENSE).................................. 815 (95) 1,261 (237)
------- ------- ------- -------
INCOME BEFORE INCOME TAXES.............................. 813 2,836 1,125 4,305
INCOME TAX PROVISION.................................... 407 1,356 563 2,098
------- ------- ------- -------
NET INCOME.............................................. $ 406 $ 1,480 $ 562 $ 2,207
======= ======= ======= =======
NET INCOME PER SHARE:
Basic................................................. $ 0.01 $ 0.04 $ 0.01 $ 0.05
======= ======= ======= =======
Diluted............................................... $ 0.01 $ 0.03 $ 0.01 $ 0.05
======= ======= ======= =======
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic................................................. 47,850 41,400 46,875 41,400
======= ======= ======= =======
Diluted............................................... 53,134 42,446 52,618 42,431
======= ======= ======= =======
</TABLE>
The accompanying Notes to Condensed Consolidated Financial Statements
are an integral part of this financial information.
2
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ELOYALTY CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
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FOR THE
SIX MONTH
PERIOD ENDED
JUNE 30,
-------------------
2000 1999
---- ----
(UNAUDITED)
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CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES:
Net income................................................ $ 562 $ 2,207
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Depreciation and amortization.......................... 3,230 3,033
Provisions for doubtful receivables.................... (61) 601
Equity losses of unconsolidated investee............... -- 252
Deferred income taxes.................................. (5,118) (1,686)
Changes in assets and liabilities:
Receivables............................................ (8,144) (18,692)
Purchases of trading securities related to deferred
compensation program.................................. (2,085) (2,059)
Other current assets................................... (1,250) (357)
Accounts payable....................................... 4,750 (485)
Accrued compensation and related costs................. 4,778 3,885
Deferred compensation funds from employees............. 2,085 2,059
Other current liabilities.............................. 4,132 (252)
Other assets........................................... (876) 240
------- --------
Net cash provided by (used in) operating
activities.......................................... 2,003 (11,254)
------- --------
CASH FLOWS USED IN INVESTING ACTIVITIES:
Capital expenditures...................................... (5,792) (695)
------- --------
Net cash used in investing activities................ (5,792) (695)
------- --------
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES:
Cash contribution from Technology Solutions Company....... 20,000 --
Transfers from Technology Solutions Company............... 4,565 14,647
Proceeds from issuance of common stock.................... 34,817 --
Proceeds from stock compensation plans.................... 6,164 --
------- --------
Net cash provided by financing activities............ 65,546 14,647
------- --------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH
EQUIVALENTS............................................... (1,749) 8
------- --------
INCREASE IN CASH AND CASH EQUIVALENTS....................... 60,008 2,706
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD.............. 13,462 4,411
------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD.................... $73,470 $ 7,117
======= ========
</TABLE>
The accompanying Notes to Condensed Consolidated Financial Statements
are an integral part of this financial information.
3
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ELOYALTY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 1 -- GENERAL
In the opinion of management, the accompanying unaudited condensed
consolidated financial statements of eLoyalty include all normal and recurring
adjustments necessary to present fairly its financial position as of June 30,
2000, the results of its operations for the three months and six months ended
June 30, 2000 and 1999, and its cash flows for the six months ended June 30,
2000 and 1999, and are in conformity with Securities and Exchange Commission
(SEC) Rule 10-01 of Regulation S-X. The financial statements include the
combined results of operations, cash flows and financial position for the period
prior to February 15, 2000, when the Company operated within Technology
Solutions Company (TSC), and subsequent to February 15, 2000, as it operated as
a separate publicly traded company. Certain reclassifications have been made to
the second quarter and year-to-date 1999 Statements of Operations to conform to
the 2000 presentation. eLoyalty operates as a single business segment.
The results of operations for any interim period are not necessarily
indicative of the results for the full year. The accompanying financial
statements should be read in conjunction with the audited combined financial
statements and the notes thereto in the Company's Annual Report on Form 10-K for
the year ended December 31, 1999.
NOTE 2 -- ELOYALTY SPIN-OFF FROM TECHNOLOGY SOLUTIONS COMPANY
eLoyalty was spun off from (TSC) into a separately traded public company on
February 15, 2000. The spin-off transaction, 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 of $0.01 per share, for every one share of TSC common stock
they owned of record as of February 9, 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:
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FEBRUARY 15, 2000
(IN 000'S) -----------------
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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
Other comprehensive loss.................................... (1,516)
</TABLE>
eLoyalty entered into a $10 million revolving line of credit facility with
Bank of America to provide cash for short-term operating obligations. TSC has
agreed to guarantee obligations under this facility through December 30, 2000.
Borrowings under this revolving credit facility generally bear interest at LIBOR
plus 0.75%. The revolving credit facility contains customary representations,
warranties, covenants and default provisions, including working capital
commitments and debt to equity ratios.
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.
4
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ELOYALTY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 3 -- COMPREHENSIVE NET INCOME (LOSS)
Comprehensive net income (loss) is comprised of the following:
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FOR THE THREE FOR THE SIX MONTHS
MONTHS ENDED ENDED
JUNE 30, JUNE 30,
(IN 000'S) ----------------- -------------------
2000 1999 2000 1999
---- ---- ---- ----
(UNAUDITED)
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Net Income................................................ $ 406 $1,480 $ 562 $2,207
Other comprehensive (loss) income:
Effect of currency translation.......................... (1,158) (336) (2,557) 8
------- ------ ------- ------
Comprehensive net (loss) income........................... $ (752) $1,144 $(1,995) $2,215
======= ====== ======= ======
</TABLE>
The accumulated other comprehensive loss, which represents the accumulated
effect of foreign currency translation adjustments, was $3.4 million and $0.8
million at June 30, 2000 and December 31, 1999, respectively.
NOTE 4 -- EARNINGS PER SHARE
The following table sets forth the computation of the shares used in the
calculation of basic and diluted earnings per share:
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FOR THE THREE FOR THE SIX
MONTHS ENDED MONTHS ENDED
JUNE 30, JUNE 30,
(IN 000'S) ---------------- ----------------
2000 1999 2000 1999
---- ---- ---- ----
(UNAUDITED)
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Basic:
Weighted average common shares outstanding................ 47,850 41,400 46,875 41,400
Diluted:
Effect of dilutive stock options.......................... 5,284 1,046 5,743 1,031
------ ------ ------ ------
Weighted average common and common share equivalents........ 53,134 42,446 52,618 42,431
====== ====== ====== ======
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NOTE 5 -- ELOYALTY COMMON STOCK ISSUANCE TO TECHNOLOGY CROSSOVER VENTURES
On May 26, 2000, eLoyalty closed its common stock purchase agreement with
several Technology Crossover Venture (TCV) entities and issued 2 million shares
of eLoyalty common stock in return for aggregate cash proceeds of $27 million.
The stock purchase price of $13.50 per share was based on the closing market
price on the signing date of the initial letter of intent. After completion of
the investment, TCV beneficially owned approximately 3.7 million shares, or
approximately 7.8%, of eLoyalty's issued and outstanding shares. eLoyalty plans
to use the funding for general corporate purposes, including continued business
and market expansion and infrastructure build-out.
NOTE 6 -- BOARD OF DIRECTORS APPROVAL OF ELOYALTY 2000 STOCK INCENTIVE PLAN
On May 12, 2000, the Board of Directors approved the eLoyalty Corporation
2000 Stock Incentive Plan. The plan is broadly based and provides for the grant
of nonqualified stock options at not less than the fair market value of shares
of eLoyalty common stock on the date of grant. A total of 2,400,000 shares of
eLoyalty common stock will be reserved and held available for issuance under the
plan.
5
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
The following Management's Discussion and other parts of this quarterly
report contain forward-looking statements and analysis. These include, without
limitation, statements containing the words "believes," "anticipates,"
"estimates," "expects," "plans," "intends," "projects," "future" and similar
expressions. These forward-looking statements are subject to potential risks and
uncertainties that could cause actual results to differ materially from those
reflected in such forward-looking statements. Factors that might cause such a
difference include, but are not limited to, those discussed in the section
entitled "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Factors That May Affect Future Results or Market Price
of Stock." Readers should also carefully review the risk factors described in
other documents the Company files from time to time with the SEC, including
Amendment No. 3 to the Registration Statement on Form S-1 filed on February 8,
2000, the Company's Annual Report on Form10-K for the fiscal year ended December
31, 1999 and the Company's Quarterly Reports on Form 10-Q for quarterly periods
in 2000. Readers are cautioned not to place undue reliance on these
forward-looking statements. They reflect management's opinions and assumptions
only as of the date they are made, and the Company undertakes no obligation to
publicly release any revisions or updates to any such forward-looking
statements.
RESULTS OF OPERATIONS
SECOND QUARTER 2000 COMPARED WITH SECOND QUARTER 1999
GENERAL
eLoyalty was spun off from TSC into a separate publicly traded company on
February 15, 2000. Accordingly, the Statement of Operations for the quarter
ended June 30, 2000 reflects eLoyalty's results as a stand-alone company. The
Statement of Operations for the quarter ended June 30, 1999 is presented as if
eLoyalty operated as a separate entity during that period, 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 Statement of Operations for the quarter ended June 30, 1999 to
conform to the 2000 presentation.
Revenues for the second quarter of 2000 were $51.0 million compared to
revenues of $36.1 million for the second quarter of 1999. The operating results
for the current quarter were approximately break even compared to operating
earnings of $2.9 million for the year-ago quarter. Net income for the current
quarter totaled $0.4 million, or $0.01 per share on a primary and fully diluted
basis, compared to net income of $1.5 million, or $0.04 per share on a primary
and $0.03 per share on a diluted basis, for the year-ago quarter.
REVENUES
Revenues increased $14.9 million, or 41.3%, to $51.0 million in the second
quarter of 2000 from $36.1 million in the prior-year quarter. Professional
service fee revenues increased $13.2 million in the quarter-over-quarter
comparison to $48.1 million in the second quarter of 2000 from $34.9 million in
the year-ago quarter. Revenues from software sales increased $0.8 million to
$1.6 million in the current-year quarter from $0.8 million in the prior-year
quarter. Support revenues increased $0.9 million to $1.3 million in the current-
year period from $0.4 million in the prior-year period.
The $14.9 million increase in revenues is due to ongoing demand for the
customer relationship management services provided by eLoyalty and resulted in
an increase in the number and average size of client projects in the
period-over-period comparison. Revenues increased in the second quarter of 2000
over the prior-year quarter in the United States, Canada and Australia by
approximately 52.3%, 26.1% and 15.8%, respectively, while revenues declined
10.3% in Europe for the same period.
6
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PROJECT PERSONNEL COSTS
Project personnel costs increased $7.9 million, or 46.5%, to $24.9 million
in the second quarter of 2000 from $17.0 million in the prior-year quarter. The
current-year increase in project personnel costs is primarily due to a 37.4%
increase in the number of billable employees in the period-over-period
comparison. Project personnel costs as a percentage of revenues increased to
48.9% in the current year period compared to 46.9% in the prior-year period,
primarily due to a 42.2% increase in the use of subcontractors in the
period-over-period comparison. eLoyalty utilizes subcontractors when internal
resources are not available to meet demands.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses increased $10.6 million, or
105.0%, to $20.7 million in the second quarter of 2000 from $10.1 million in the
prior-year quarter. Selling and marketing expenses increased
quarter-over-quarter as a result of our continued expansion of the business
development and sales and marketing groups, and our continued investment in the
brand building and name recognition of eLoyalty as a stand-alone company.
General and administrative expenses increased in the period-over-period
comparison primarily due to the continued build-out of our corporate
infrastructure, finance, treasury, legal, human resources, technical support and
management personnel additions, and an increase in non-labor related expenses
attributable to the growth in billable consultants. As a result of the
foregoing, selling, general and administrative expenses increased as a
percentage of revenues to 40.6% in the current-year period from 28.0% in the
prior-year period.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses increased $1.0 million, or 76.9%, to $2.3
million in second quarter of 2000 from $1.3 million in the prior-year quarter.
Research and development expenses increased as a percentage of revenues from
3.7% in the second quarter of 1999 to 4.5% in the current-year quarter,
primarily due to increased investments in the Loyalty Lab, including the
addition of 20 developers.
TSC CORPORATE SERVICES EXPENSES
TSC contractually agreed to provide certain corporate services to eLoyalty
from the date of the spin-off through June 30, 2000. The shared services
agreement between eLoyalty and TSC has been extended into the third quarter of
2000 to provide selected support services in the IT, accounting and human
resources areas.
TSC corporate services expenses decreased $1.8 million, or 50.0%, to $1.8
million in the second quarter of 2000 from $3.6 million in the prior-year
quarter. TSC corporate services expenses decreased as a percentage of total
revenues to 3.5% in the current-year quarter from 9.8% in the prior-year
quarter. This was due primarily to the elimination of the allocation to eLoyalty
of TSC senior management salary expenses in the current-year quarter.
GOODWILL AMORTIZATION
Goodwill amortization expenses remained relatively flat at $1.2 million in
the second quarter of 2000 compared to $1.3 million in the prior-year quarter.
Goodwill amortization as a percentage of revenues declined in the second quarter
of 2000 to 2.4% from 3.5% in the prior-year quarter, reflecting the growth in
revenues in the quarter-to-quarter comparison.
OTHER INCOME (EXPENSE)
eLoyalty recognized non-operating other income of $0.8 million in the
second quarter of 2000 compared to a non-operating other loss of $0.1 million in
the prior-year quarter. The $0.9 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 the current-year period over the
prior-year period.
7
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PROVISION FOR INCOME TAXES
The provision for income taxes decreased to $0.4 million in the second
quarter of 2000 compared to $1.4 million in the prior-year quarter, primarily
due to a decline in pre-tax income in the period-over-period comparison. The
effective tax rate increased slightly to 50.0% in the current-year quarter
compared to 47.8% in the prior-year quarter.
FIRST SIX MONTHS OF 2000 COMPARED WITH FIRST SIX MONTHS OF 1999
GENERAL
eLoyalty was spun off from TSC into a separate publicly traded company on
February 15, 2000. The financial statements for the first six months of 2000
include the combined results of operations, cash flows and financial position
for the period prior to February 15, 2000, when eLoyalty operated within TSC,
and subsequent to February 15, 2000, as eLoyalty operated as a separate publicly
traded company. The Statement of Operations for the six months ended June 30,
1999 is presented as if eLoyalty operated as a separate entity during that
period and includes a cost allocation of certain TSC general corporate expenses,
which were not directly related to eLoyalty's operations. These costs were
allocated proportionately to eLoyalty based on revenue and headcount. Certain
reclassifications have been made to the Statement of Operations for the six
months ended June 30, 1999 to conform to the 2000 presentation.
Revenues for the first six months of 2000 were $97.1 million compared to
revenues of $67.6 million for the first six months of 1999. The operating
results for the current-year period was $0.1 million operating loss compared to
operating earnings of $4.5 million for the year-ago period. Net income for the
current six-month period totaled $0.6 million, or $0.01 per share on a primary
and fully diluted basis, compared to net income of $2.2 million, or $0.05 per
share on a primary and fully diluted basis, for the year-ago period.
REVENUES
Revenues increased $29.5 million, or 43.6%, to $97.1 million in the first
six months of 2000 from $67.6 million in the prior-year period. Professional
service fee revenues increased $23.9 million in the year-over-year comparison to
$89.6 million in 2000 from $65.7 million in the year-ago period. Revenues from
software sales increased $4.0 million to $5.2 million in the current-year period
from $1.2 million in the prior-year period. Support revenues increased $1.6
million to $2.3 million in the current-year period from $0.7 million in the
prior-year period.
The $29.5 million increase in revenues is due to ongoing demand for the
customer relationship management services provided by eLoyalty and resulted in
an increase in the number and average size of client projects in the
period-over-period comparison. Current year-to-date revenues increased in the
United States, Canada and Australia by approximately 59.4%, 27.3% and 27.4%,
respectively, over the comparable prior-year period, while revenues declined
22.9% in Europe over the same period.
PROJECT PERSONNEL COSTS
Project personnel costs increased $15.1 million, or 48.7%, to $46.1 million
in the first six months of 2000 from $31.0 million in the prior-year period. The
current-year increase in project personnel costs is primarily due to a 37.4%
increase in the number of billable employees in the period-over-period
comparison. Project personnel costs as a percentage of revenues increased to
47.5% in the current-year period compared to 45.9% in the prior-year period,
primarily due to a 75.8% increase in the use of subcontractors in the
period-over-period comparison. eLoyalty utilizes subcontractors when internal
resources are unavailable to meet demand.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses increased $20.0 million, or
98.0%, to $40.4 million in the first six months of 2000 from $20.4 million in
the prior-year period. Selling and marketing expenses increased
period-over-period as a result of our continued expansion of the business
development and sales and marketing
8
<PAGE> 11
groups, and our continued investment in the brand building and name recognition
of eLoyalty as a stand-alone company.
General and administrative expenses increased in the period-over-period
comparison, primarily due to the continued build-out of our corporate
infrastructure, finance, treasury, legal, human resources, technical support and
management personnel additions, and an increase in non-labor related expenses
attributable to growth in billable consultants. As a result of the foregoing,
selling, general and administrative expenses increased as a percentage of
revenues to 41.5% in the current-year period from 30.1% in the prior-year
period.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses increased $1.8 million, or 72.0%, to $4.3
million in first six months of 2000 from $2.5 million in the prior-year period.
Research and development expenses increased as a percentage of revenues from
3.7% in the prior-year period to 4.5% in the current year period, primarily due
to our increased investment in the Loyalty Lab, including the addition 20
developers.
TSC
TSC corporate services expenses decreased $2.7 million, or 40.3%, to $4.0
million in the first six months of 2000 from $6.7 million in the prior-year
period. TSC corporate services expenses decreased as a percentage of total
revenues to 4.1% in the current-year period from 9.9% in the prior-year period.
This was due to the elimination of the allocation to eLoyalty of TSC senior
management salary expenses in the current-year period.
GOODWILL AMORTIZATION
Goodwill amortization expenses remained relatively flat at $2.5 million in
both the first six months of 2000 and 1999, respectively. Goodwill amortization
as a percentage of revenues declined in the current year period to 2.6% from
3.7% in the prior-year period, reflecting the increase in revenues in the
current-year period over the prior-year period.
OTHER INCOME (EXPENSE)
eLoyalty recognized non-operating other income of $1.3 million in the first
six months of 2000 compared to a non-operating other loss of $0.2 million in the
prior-year period. The $1.5 million increase in non-operating other income is
primarily due to incremental interest income earned as a result of a higher
average cash and cash equivalent balances in the current-year period over the
prior-year period.
PROVISION FOR INCOME TAXES
The provision for income taxes decreased to $0.6 million in the first six
months of 2000 compared to $2.1 million in the prior-year period, primarily as a
result of a decline in pre-tax income in the period-over-period comparison. The
effective tax rate increased slightly to 50.0% in the current-year period from
48.7% in the prior-year period.
LIQUIDITY AND CAPITAL RESOURCES
eLoyalty, principal capital requirements are to fund working capital needs,
capital expenditures and other investments in order to support revenue growth.
Following the spin-off, eLoyalty no longer receives operational funding from TSC
or TSC guarantees (except as described below) of eLoyalty financial or other
obligations. eLoyalty no longer participates in the TSC cash management program
and so has implemented its own cash management system.
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At June 30, 2000, eLoyalty had cash and cash equivalents of approximately
$73.5 million, an increase of approximately $60.0 million from December 31,
1999. This increase is due primarily to the cash generated from the financing
activities described below.
Net cash of $2.0 million was provided by operations for the first six
months of 2000 compared to $11.3 million used in operations in the prior-year
period. eLoyalty's generation of positive cash flows from operations during the
first six months of 2000 as compared to the same period in the prior year is due
primarily to revenue growth and improved working capital management, partially
offset by increased working capital requirements associated with that revenue
growth.
Cash flows used in investing activities related primarily to capital
expenditures for computer, furniture, equipment and leasehold improvements in
connection with eLoyalty's build-out of its infrastructure as a separate
publicly traded company. Capital expenditures for the year-to-date period ended
June 30, 2000 increased to $5.8 million from $0.7 million in the prior-year
period. Total capital expenditures are expected to approximate between $15-$20
million in calendar year 2000. Actual expenditures may vary as leases are being
pursued as a possible alternative to asset purchases.
Cash flows provided by financing activities increased $50.9 million to
$65.5 million in the current-year period from $14.6 million in the same period
in 1999. Cash from financing increased primarily as a result of the issuance of
4.5 million shares of common stock to venture capital investors for net proceeds
of $34.8 million, a $20 million cash contribution from TSC as part of the
spin-off on February 15, 2000 and cash proceeds received in connection with the
exercise of employee stock options and purchases under the Company's employee
stock purchase plan.
In connection with the spin-off, eLoyalty entered into a $10 million
revolving credit facility with Bank of America to provide the cash needed for
short-term operating obligations. TSC has agreed to guarantee obligations under
the facility through December 30, 2000. Borrowings under the revolving credit
facility bear interest at LIBOR plus 0.75 %. The credit revolving facility
contains customary representations, warranties, covenants and default
provisions, including working capital commitments and debt to equity ratios. At
June 30, 2000, eLoyalty had three letters of credit outstanding totaling $0.2
million, to secure new office space in the United States, Europe and Australia,
and had $9.8 million of credit available under the revolving credit facility.
On July 24, 2000, eLoyalty announced the formation of a new $30 million
venture capital fund, eLoyalty Ventures, L.L.C., with Bain Capital, Sutter Hill
Ventures and Technology Crossover Ventures. eLoyalty Ventures plans to focus on
investing in early-stage electronic customer relationship management (eCRM)
software companies. eLoyalty has committed to invest, through another newly
formed entity, up to $14.7 million in eLoyalty Ventures. eLoyalty anticipates
that it will have sufficient cash resources and available credit to satisfy its
capital commitment, as and when required.
eLoyalty anticipates that current cash resources, together with existing
sources of liquidity and anticipated cash flows from operations, should be
sufficient to satisfy eLoyalty's working capital and capital expenditure needs,
as well as its other existing cash commitments, through at least the next twelve
months.
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 (January 1, 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
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in financial statements. On June 26, 2000, the SEC issued SAB 101B, an amendment
to SAB 101 which delays the implementation of SAB 101 until no later than the
fourth fiscal quarter of fiscal years beginning after December 15, 1999. The
Company anticipates that the adoption of SAB 101 in the fourth quarter of this
year will not have a material effect on its results of operations, financial
position or cash flows.
YEAR 2000 ISSUE
eLoyalty knows of no significant Year 2000 related failures which have
affected Company-provided software or services, corporate support services
provided to eLoyalty by TSC in connection with the spin-off or other internal
Company systems.
Since its inception as a TSC business unit, eLoyalty has designed and
developed software and systems solutions for its clients. In doing so, eLoyalty
has recommended, implemented and at times customized third-party software
packages for, and licensed its own propriety software to, its clients. Due to
the large number of engagements eLoyalty has undertaken over the years, there
can be no assurance that all such software and systems will be Year 2000
compliant on 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:
- eLoyalty's ability to manage rapid growth, expansion into new geographic
and market areas and development and introduction of new services
offerings, including its timely and cost-effective implementation of
enhanced operating and financial systems and procedures;
- challenges in attracting, training, motivating and retaining highly
skilled management, strategic, technical, product development and other
professional employees in an extremely competitive information technology
labor market;
- the rapid pace of technological innovation in the information technology
industry, including frequent technological advances and new product
introductions and enhancements, and eLoyalty's continuing ability to
create solutions that are based on leading technologies, adaptable to
evolving standards and responsive to client needs and preferences;
- continuing intense competition in the information technology services
industry generally and in particular among those focusing on the
provision of eCRM services and software, including both firms with
significantly greater financial and technical resources than the Company
and new entrants;
- eLoyalty's ability to manage the risks associated with client projects in
general as well as new services offerings, including risks relating to
unanticipated variations in the number, size and scope of projects, the
cancellation or deferral of major client projects or follow-on phases of
engagements in process, 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;
- continued access to sufficient debt or equity capital to meet the
Company's future operating and financial needs;
- protection of the Company's technology, proprietary information and other
intellectual property rights or challenges to the Company'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;
and
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- the overall demand for eCRM services and software and information
technology generally, as well as general business, capital market and
economic conditions and volatility.
ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
eLoyalty provides eCRM solutions to clients in a number of countries,
including the United States, Canada, the United Kingdom, Germany, France,
Switzerland and Australia. Revenues denominated in foreign currencies
represented approximately 15%-16% of total revenues in the three-month and
six-month periods ended June 30, 2000 and approximately 22%-24% of revenues in
the year-ago periods. The Company expects that a similar percentage of its
international revenues and costs will be denominated in foreign currencies in
the future. Although eLoyalty has not yet experienced material fluctuations in
its results of operations due to foreign currency exchange rate changes, its
financial results could be adversely affected by changes in foreign currency
exchange rates or weak economic conditions in those foreign markets.
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PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES.
On May 26, 2000, the Company completed the issuance and sale of 2.0 million
newly issued shares of its common stock to several Technology Crossover Ventures
entities for an aggregate purchase price of $27 million. The purchase price of
$13.50 per share was the closing market price of eLoyalty common stock on April
18, 2000, the date of the letter of intent relating to the transaction. These
shares were issued without registration under the Securities Act of 1933
pursuant to the exemption afforded by Section 4(2) of the Securities Act.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
a) Exhibits
10.1 Common Stock Purchase Agreement, dated as of May 26, 2000, among
eLoyalty Corporation and TCV IV, L.P., TCV IV Strategic Partners, L.P.,
TCV III (GP), TCV III (Q), L.P. and TCV III Strategic Partners, L.P.
10.2 Investor Rights Agreement, dated as of May 26, 2000, among eLoyalty
Corporation and TCV IV, L.P., TCV IV Strategic Partners, L.P., TCV III
(GP), TCV III (Q), L.P. and TCV III Strategic Partners, L.P.
10.3* eLoyalty Corporation 2000 Stock Incentive Plan
27.1 Financial Data Schedule
b) Reports on Form 8-K
On April 25, 2000, the Company filed a Current Report on Form 8-K which
reported under Item 5 the issuance and sale of 2.0 million shares of
common stock to Technology Crossover Ventures at $13.50 per share, the
closing market price on the letter of intent date.
-------------------------
* Included as Exhibit 4.5 to the Company's Registration Statement on Form S-8
(Registration No. 333-42284) filed with the SEC on July 26, 2000 and
incorporated herein by reference.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Lake Forest, State of
Illinois, on August 14, 2000.
/s/ TIMOTHY J. CUNNINGHAM
--------------------------------------
Timothy J. Cunningham
Senior Vice President and Chief
Financial Officer
(Duly authorized signatory and
principal financial officer)
ELOYALTY CORPORATION
Date: August 14, 2000
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INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
------- -------------------
<S> <C>
10.1 Common Stock Purchase Agreement dated, as of May 26, 2000,
among eLoyalty Corporation and TCV IV, L.P., TCV IV
Strategic Partners, L.P., TCV III (GP), TCV III (Q), L.P.
and TCV III Strategic Partners, L.P.
10.2 Investor Rights Agreement, dated as of May 26, 2000, among
eLoyalty Corporation and TCV IV, L.P., TCV IV Strategic
Partners, L.P., TCV III (GP), TCV III (Q), L.P., and TCV III
Strategic Partners, L.P.
10.3* eLoyalty Corporation 2000 Stock Incentive Plan
27.1 Financial Data Schedule
</TABLE>
-------------------------
* Included as Exhibit 4.5 to the Company's Registration Statement on Form S-8
(Registration No. 333-42284) filed with the SEC on July 26, 2000 and
incorporated herein by reference.
