1
UNITED STATES
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 SEPTEMBER 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)
DELAWARE 36-4304577
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
150 FIELD DRIVE
SUITE 250
LAKE FOREST, ILLINOIS 60045
(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 NOVEMBER 7, 2000 WAS 49,837,435.
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TABLE OF CONTENTS
PAGE
----
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..... 13
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K............................... 14
Signatures ............................................................... 15
Exhibit Index ............................................................... 16
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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)
SEPTEMBER 30, DECEMBER 31,
2000 1999
---- ----
(UNAUDITED)
ASSETS:
CURRENT ASSETS:
Cash and cash equivalents ...................................... $ 61,543 $ 13,462
Marketable securities .......................................... 10,595 7,175
Receivables (less allowances of $2,130 and $2,084, respectively) 65,247 44,056
Deferred income taxes .......................................... 13,296 9,057
Prepaid expenses ............................................... 2,624 3,093
Other current assets ........................................... 1,891 1,072
--------- ---------
Total current assets .................................. 155,196 77,915
COMPUTERS, FURNITURE AND EQUIPMENT, NET ........................ 10,339 2,284
GOODWILL, NET .................................................. 8,363 12,129
DEFERRED INCOME TAXES .......................................... 3,190 2,387
LONG-TERM RECEIVABLES AND OTHER ................................ 3,084 1,888
--------- ---------
Total assets .......................................... $ 180,172 $ 96,603
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY:
CURRENT LIABILITIES:
Accounts payable ............................................... $ 4,482 $ 640
Accrued compensation and related costs ......................... 17,738 11,687
Deferred compensation .......................................... 10,387 7,175
Other current liabilities ...................................... 4,758 3,486
--------- ---------
Total current liabilities ............................. 37,365 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 49,834,390 shares and 41,400,000
shares, respectively ...................................... 498 414
Additional paid-in capital ..................................... 140,846 963
Net advances from Technology Solutions Company ................. -- 74,048
Retained earnings .............................................. 3,505 --
Other .......................................................... (2,042) (1,810)
--------- ---------
Total stockholders' equity ............................ 142,807 73,615
--------- ---------
Total liabilities and stockholders' equity ............ $ 180,172 $ 96,603
========= =========
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)
FOR THE FOR THE
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------ -------------
2000 1999 2000 1999
---- ---- ---- ----
(UNAUDITED) (UNAUDITED)
REVENUES .................................................. $ 56,818 $ 40,016 $ 153,957 $ 107,652
Project personnel........................................ 28,647 18,661 74,736 49,676
---------- ---------- ----------- ----------
GROSS PROFIT................................................ 28,171 21,355 79,221 57,976
---------- ---------- ----------- ----------
OTHER COSTS AND EXPENSES:
Selling, general and administrative...................... 25,034 15,011 69,404 42,082
Research and development................................. 2,277 1,428 6,605 3,935
Goodwill amortization.................................... 1,243 1,247 3,731 3,748
---------- ---------- ----------- ----------
28,554 17,686 79,740 49,765
---------- ---------- ----------- ----------
OPERATING (LOSS) INCOME .................................... (383) 3,669 (519) 8,211
OTHER INCOME (EXPENSE)...................................... 1,079 (198) 2,340 (435)
---------- ---------- ----------- ----------
INCOME BEFORE INCOME TAXES.................................. 696 3,471 1,821 7,776
INCOME TAX PROVISION........................................ 348 1,592 911 3,690
---------- ---------- ----------- ----------
NET INCOME.................................................. $ 348 $ 1,879 $ 910 $ 4,086
========== ========== =========== ==========
NET INCOME PER SHARE:
Basic ................................................... $ 0.01 $ 0.05 $ 0.02 $ 0.10
========== ========== =========== ==========
Diluted.................................................. $ 0.01 $ 0.04 $ 0.02 $ 0.09
========== ========== =========== ==========
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic ................................................... 49,669 41,400 47,692 41,400
========== ========== =========== ==========
Diluted.................................................. 54,381 44,571 53,224 43,144
========== ========== =========== ==========
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 CASH FLOWS
(IN THOUSANDS)
FOR THE
NINE MONTHS
ENDED
SEPTEMBER 30,
2000 1999
---- ----
(UNAUDITED)
CASH FLOWS USED IN OPERATING ACTIVITIES:
Net income.......................................................................... $ 910 $ 4,086
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization.................................................... 5,266 4,987
Provisions for doubtful receivables.............................................. 46 1,395
Equity losses of unconsolidated investee......................................... -- 463
Deferred income taxes............................................................ (5,596) (5,622)
Changes in assets and liabilities:
Receivables...................................................................... (22,585) (19,610)
Purchases of trading securities related to deferred compensation program......... (3,427) (2,228)
Other current assets............................................................. (422) (259)
Accounts payable................................................................. 3,839 (255)
Accrued compensation and related costs........................................... 6,464 3,751
Deferred compensation funds from employees....................................... 3,212 2,228
Other current liabilities........................................................ 1,678 (239)
Other assets..................................................................... (1,813) (133)
----------- -------------
Net cash used in operating activities......................................... (12,428) (11,436)
------------ ------------
CASH FLOWS USED IN INVESTING ACTIVITIES:
Capital expenditures................................................................ (9,433) (1,637)
----------- ------------
Net cash used in investing activities......................................... (9,433) (1,637)
----------- ------------
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES:
Cash contribution from Technology Solutions Company................................. 20,000 --
Transfers from Technology Solutions Company......................................... 4,565 18,878
Proceeds from issuance of common stock.............................................. 34,973 --
Proceeds from stock compensation plans.............................................. 8,570 --
----------- ------------
Net cash provided by financing activities..................................... 68,108 18,878
----------- ------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH
EQUIVALENTS......................................................................... 1,834 438
----------- ------------
INCREASE IN CASH AND CASH EQUIVALENTS.................................................. 48,081 6,243
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD......................................... 13,462 4,411
----------- ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD............................................... $ 61,543 $ 10,654
=========== ============
The accompanying Notes to Condensed Consolidated Financial Statements
are an integral part of this financial information.
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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 Corporation (eLoyalty or the
Company) include all normal and recurring adjustments necessary to present
fairly its financial position as of September 30, 2000, the results of its
operations for the three months and nine months ended September 30, 2000 and
1999, and its cash flows for the nine months ended September 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 third quarter
1999 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:
(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
Other comprehensive loss..................... (1,516)
eLoyalty entered into a $10 million revolving credit facility with Bank of
America to provide cash for short-term operating obligations. TSC agreed to
guarantee obligations under this facility through December 30, 2000, the
expiration date of the facility. 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.
eLoyalty is in the process of seeking to renew its credit facility with Bank of
America.
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.
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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
Comprehensive net income is comprised of the following:
FOR THE THREE FOR THE NINE MONTHS
MONTHS ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------- -------------
2000 1999 2000 1999
---- ---- ---- ----
(UNAUDITED) (UNAUDITED)
Net Income...................................... $ 348 $ 1,879 $ 910 $ 4,086
Other comprehensive income:
Effect of currency translation............... 2,639 429 82 437
---------- ---------- ----------- ----------
Comprehensive net income........................ $ 2,987 $ 2,308 $ 992 $ 4,523
========== ========== =========== ==========
The accumulated other comprehensive loss, which represents the accumulated
effect of foreign currency translation adjustments, was $0.77 million at
September 30, 2000 and $0.85 million at December 31, 1999.
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:
FOR THE THREE FOR THE NINE
MONTHS ENDED MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------- -------------
2000 1999 2000 1999
---- ---- ---- ----
(UNAUDITED) (UNAUDITED)
Basic:
Weighted average common shares outstanding............... 49,669 41,400 47,692 41,400
Diluted:
Effect of dilutive stock options......................... 4,712 3,171 5,532 1,744
---------- ---------- ----------- ----------
Weighted average common and common share equivalents........ 54,381 44,571 53,224 43,144
========== ========== =========== ==========
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 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. The funding
from this transaction will be used 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 has been reserved and held available for issuance under
the plan.
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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 that are based on current management
expectations, forecasts and assumptions. These include, without limitation,
statements containing the words "believes," "anticipates," "estimates,"
"expects," "plans," "intends," "projects," "future" and similar expressions,
references to plans, strategies, objectives and anticipated future performance,
and other statements that are not strictly historical in nature. These
forward-looking statements are subject to risks and uncertainties that could
cause actual results to differ materially from those expressed or implied by the
forward-looking statements. Such risks, uncertainties and other associated
factors that might cause such a difference include, 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 Form 10-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 opinions, assumptions and estimations only as of the
date they are made, and the Company 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. With nearly 1,000
professionals in offices throughout North America, Europe and Australia,
eLoyalty's broad range of electronic customer relationship management (eCRM)
related services include creating a business strategy, defining a technical
architecture, selecting, implementing and integrating appropriate eCRM software
applications, and providing ongoing support for the multi-vendor systems.
eLoyalty's revenues are generated primarily from professional services,
which are billed principally on a time and materials basis. Revenues are
recognized for time and material engagements as services are rendered. eLoyalty
has, on occasions, contracted phases of a project on a fixed fee basis. Other
growing revenue contributors include fees generated from hosting and support
services and eProfile combined with professional services. Support and hosting
revenues, and revenues from eLoyalty's alliance with eProfile to provide an
Internet banking solution, represented 3.2% and 1.0% of total revenues for the
year-to-date periods ended September 30, 2000 and September 30, 1999,
respectively. eLoyalty also generates revenues from the licensing of its
proprietary software. To date, software revenues have not exceeded 4% of total
revenues. Software revenues have declined $1.4 million in the third quarter of
2000 from second quarter 2000, due in part to the Company's focus on building
recurring annuity revenue streams for software as a part of broader solutions
offerings including Loyalty Foundation hosting and eProfile combined with
professional services.
The Company'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. The remainder of eLoyalty's
costs relate primarily to selling, general and administrative expenses, research
and development expenses and goodwill amortization expense. Selling and
marketing expenses are comprised of labor costs and expenses incurred by the
marketing and business development groups. General and administrative expenses
include labor costs and expenses incurred by the eLoyalty management team and
administrative support staff, and service fee expenses relating to
administrative and technical support services provided by TSC to eLoyalty.
Goodwill amortization expense relates primarily to the Bentley acquisition in
June of 1997.
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RESULTS OF OPERATIONS
THIRD QUARTER 2000 COMPARED WITH THIRD 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 September 30, 2000 reflects eLoyalty's results as a stand-alone company.
The Statement of Operations for the quarter ended September 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 September 30, 1999 to conform to the 2000 presentation.
PERFORMANCE OVERVIEW
Revenues for the third quarter of 2000 were $56.8 million compared to
revenues of $40.0 million for the third quarter of 1999. The operating loss for
the current quarter was $0.4 million compared to operating earnings of $3.7
million for the year-ago quarter. Net income for the current quarter totaled
$0.3 million, or $0.01 per share on a primary and fully diluted basis compared
to net income of $1.9 million, or $0.05 per share on a primary and $0.04 per
share on a diluted basis, for the year-ago quarter.
REVENUES
Revenues increased $16.8 million, or 42.0%, to $56.8 million in the third
quarter of 2000 from $40.0 million in the prior-year quarter. The $16.8 million
increase in revenues is due to the combined effect of strong demand for the
customer relationship management services provided by eLoyalty and higher
average billing rates in the period-over-period comparison.
Professional service fee revenues increased $15.3 million, or 39.2%, in the
quarter-over-quarter comparison to $54.4 million in the third quarter of 2000
from $39.1 million in the year-ago quarter. Revenues from Support, Hosting and
eProfile have increased $1.8 million to $2.2 million in the current-year period
from $0.4 million in the prior-year period. Software revenues decreased $0.3
million to $ 0.2 million in the current-year period from $0.5 million in the
prior-year period due in part to the Company's focus on building recurring
annuity revenue streams for software as a part of broader solutions offerings,
including Loyalty Foundation hosting and eProfile.
PROJECT PERSONNEL COSTS
Project personnel costs increased $10.0 million, or 53.5%, to $28.7 million
in the third quarter of 2000 from $18.7 million in the prior-year quarter. The
current period increase in project personnel costs is primarily due to a 39.5%
increase in the number of billable employees in the period-over-period
comparison. Project personnel costs as a percentage of revenues increased to
50.4% in the current year period compared to 46.6% in the prior-year period,
primarily due to a 33.3% increase in the use of subcontractors in the
period-over-period comparison. eLoyalty utilizes subcontractors, which are more
costly than employee project personnel, when internal resources are not
available to meet demands.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses increased $10.0 million, or
66.8%, to $25.0 million in the third quarter of 2000 from $15.0 million in the
prior-year quarter. This increase primarily resulted from the extended
implementation of, and higher than anticipated expenses associated with, the
corporate infrastructure build-out, which is expected to continue into the
fourth quarter of 2000.
General and administrative expenses increased in the period-over-period
comparison primarily due to the continued build-out of our corporate
infrastructure which includes finance, treasury, legal, human resources and
technical systems support.
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TSC corporate services expenses decreased from $2.8 million in the third quarter
of 1999 to $0.8 million in the current-year quarter, primarily due to the
continued migration from TSC to eLoyalty systems and the elimination of certain
services provided by TSC as a result of the infrastructure build-out. 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 fourth quarter of 2000 to
provide certain technical system support services. eLoyalty believes the TSC
support services will not be required after the fourth quarter of 2000, when the
Company expects to complete its final migration from the TSC systems. Selling
and marketing expenses increased quarter-over-quarter primarily as a result of
our continued expansion of the business development group.
As a result of the foregoing, selling, general and administrative expenses
increased as a percentage of revenues to 44.1% in the current-year period from
37.5% in the prior-year period.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses increased $0.9 million, or 59.4%, to $2.3
million in third quarter of 2000 from $1.4 million in the prior-year quarter.
Research and development expenses increased as a percentage of revenues from
3.6% in the third quarter of 1999 to 4.0% in the current-year quarter, primarily
due to an increased investment in the Loyalty Lab, including the addition of
developers since the third quarter of 1999. The Company believes the Loyalty Lab
will continue to be an important part of its loyalty solutions offerings,
enhancing their effectiveness, positioning the Company to gain early access to
and familiarity with emerging technology and offering a demonstration center for
its clients.
GOODWILL AMORTIZATION
Goodwill amortization expenses were $1.2 million for both the third quarter
of 2000 and third quarter of 1999. Goodwill amortization as a percentage of
revenues declined in the third quarter of 2000 to 2.2% from 3.1% in the
prior-year quarter, reflecting the growth in revenues in the quarter-to-quarter
comparison.
OPERATING (LOSS) INCOME
The Company experienced an operating loss for the current quarter of $0.4
million compared to operating earnings of $3.7 million in the year-ago period.
The current quarter's operating loss is attributable primarily to the costs
associated with the implementation of new infrastructure systems as the Company
completes its transition from TSC's systems, as well as a decline in software
revenues.
OTHER INCOME (EXPENSE)
eLoyalty recognized non-operating other income of $1.1 million in the third
quarter of 2000 compared to a non-operating other loss of $0.2 million in the
prior-year quarter. The $1.3 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 the current-year period over the
prior-year period.
PROVISION FOR INCOME TAXES
The provision for income taxes decreased to $0.3 million in the third
quarter of 2000 compared to $1.6 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 to 50.0% in the current-year quarter compared to
45.9% in the prior-year quarter.
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FIRST NINE MONTHS OF 2000 COMPARED WITH FIRST NINE 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 nine 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 nine months ended September
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 nine
months ended September 30, 1999 to conform to the 2000 presentation.
PERFORMANCE OVERVIEW
Revenues for the first nine months of 2000 were $154.0 million compared to
revenues of $107.7 million for the first nine months of 1999. The operating loss
for the current-year period was a $0.5 million compared to operating earnings of
$8.2 million for the year-ago period. Net income for the current nine-month
period totaled $0.9 million, or $0.02 per share on a primary and fully diluted
basis, compared to net income of $4.1 million, or $0.10 per share on a primary
and $0.09 per share on a fully diluted basis, for the year-ago period.
REVENUES
Revenues increased $46.3 million, or 43.0%, to $154.0 million in the first
nine months of 2000 from $107.7 million in the prior-year period. The $46.3
million increase in revenues is due to strong demand for the customer
relationship management services provided by eLoyalty and higher average billing
rates in the period-over-period comparison.
Professional service fee revenues increased $38.6 million, or 36.8%, in the
year-over-year comparison to $143.6 million in 2000 from $105.0 million in the
year-ago period. Software revenues increased $3.8 million to $5.4 million in the
current-year period from $1.6 million in the prior-year period. Revenues from
Support, Hosting and eProfile have increased $3.9 million to $5.0 million in the
current-year period from $1.1 million in the prior-year period. This is due the
Company's continuing focus on building annuity revenue streams as part of a
broader solution offering.
PROJECT PERSONNEL COSTS
Project personnel costs increased $25.0 million, or 50.4%, to $74.7 million
in the first nine months of 2000 from $49.7 million in the prior-year period.
The current-year increase in project personnel costs is primarily due to a 39.5%
increase in the number of billable employees in the period-over-period
comparison. Project personnel costs as a percentage of revenues increased to
48.5% in the current-year period compared to 46.1% in the prior-year period,
primarily due to a 33.3% increase in the use of subcontractors in the
period-over-period comparison. eLoyalty utilizes subcontractors, which are more
costly than employee project personnel, when internal resources are unavailable
to meet demand.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses increased $27.3 million, or
64.9%, to $69.4 million in the first nine months of 2000 from $42.1 million in
the prior-year period. This increase primarily resulted from the implementation
of, and higher than anticipated expenses associated with, the corporate
infrastructure build-out, which is expected to continue into the fourth quarter
of 2000.
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General and administrative expenses increased in the period-over-period
comparison primarily due to the continued build-out of our corporate
infrastructure which includes finance, treasury, legal, human resources and
technical systems support. TSC corporate services expenses decreased from $9.5
million in the prior year-to-date period to $4.8 million in the current
year-to-date period, primarily due to the continued migration from TSC to
eLoyalty systems and the elimination of certain services provided by TSC as a
result of the infrastructure build-out. Selling and marketing expenses increased
period-over-period as a result of our continued expansion of the business
development group.
As a result of the foregoing, selling, general and administrative expenses
increased as a percentage of revenues to 45.1% in the current-year period from
39.1% in the prior-year period.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses increased $2.7 million, or 67.8%, to $6.6
million in first nine months of 2000 from $3.9 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 4.3% in the current year period, primarily due
to our increased investment in the Loyalty Lab, including the addition of
developers since the third quarter of 1999. The Company believes the Loyalty Lab
will continue to be an important part of its loyalty solutions offerings,
enhancing their effectiveness, positioning the Company to gain early access to
and familiarity with emerging technology and offering a demonstration center for
its clients.
GOODWILL AMORTIZATION
Goodwill amortization expenses were $3.7 million for both the first nine
months of 2000 and 1999. Goodwill amortization as a percentage of revenues
declined in the current-year period to 2.4% from 3.5% in the prior-year period,
reflecting the increase in revenues in the current-year period over the
prior-year period.
OPERATING (LOSS) INCOME
The operating loss for the current year-to-date period was $0.5 million
compared to operating earnings of $8.2 million in the comparable 1999
year-to-date period. The current period loss is attributable primarily to costs
associated with the implementation of new infrastructure systems as the Company
completes the transition from TSC's systems.
OTHER INCOME (EXPENSE)
eLoyalty recognized non-operating other income of $2.3 million in the first
nine months of 2000 compared to a non-operating other loss of $0.4 million in
the prior-year period. The $2.7 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 $0.9 million in the first nine
months of 2000 compared to $3.7 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 to 50.0% in the current-year period from 47.4% in
the prior-year period.
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LIQUIDITY AND CAPITAL RESOURCES
eLoyalty's 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 has implemented its own cash management system.
At September 30, 2000, eLoyalty had cash and cash equivalents of
approximately $61.5 million, an increase of approximately $48.1 million from
December 31, 1999. This increase is due primarily to the cash generated from the
financing activities described below.
Net cash of $12.4 million was used by operations for the first nine months
of 2000, compared to $11.4 million of cash used in operations during the
prior-year period. eLoyalty's operating cash needs in the current-year period
were adversely impacted by a deterioration in collection activities and an
increase in receivables, reflected by an increase in DSO (Days Sales
Outstanding) to 89 days in the third quarter from 82 days in the second quarter.
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. Capital expenditures
for the year-to-date period ended September 30, 2000 increased to $9.4 million
from $1.6 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 $49.2 million to
$68.1 million in the current-year period from $18.9 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 aggregating $8.0 million
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 agreed to guarantee obligations under the
facility through December 30, 2000, the expiration date of the facility.
Borrowings under the revolving credit facility 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. eLoyalty is in the process of seeking to
renew its credit facility with Bank of America. Although no assurance can be
given, the Company expects that it will secure a renewal or replacement of this
credit facility, on similar terms and conditions, before the expiration of the
current facility.
At September 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 entities associated with
Bain Capital, Sutter Hill Ventures and Technology Crossover Ventures. eLoyalty
Ventures plans to focus on investing in early-stage 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.
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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 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 the adoption of SAB 101 in the fourth quarter of this year. The
Company is reviewing the requirements of this standard and has not determined
the impact on its consolidated financial statements.
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 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 risks, uncertainties and other 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:
- the ability to attract new clients and continuation of existing and
new business from existing clients;
- reliance on major clients and suppliers;
- the ability to manage the risks associated with increasingly complex
client projects in general as well as new services offerings,
including risks involving 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;
- the ability to manage rapid 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 eLoyalty 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;
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- 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
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;
- continued access to sufficient debt or equity capital to meet the
Company's 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 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. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
eLoyalty provides eCRM solutions to clients outside of the United States,
including those in Canada, Europe and Australia. The transacting of business in
foreign currencies exposes eLoyalty to potential market rate risk resulting from
foreign currency exchange rate fluctuations or weakening economic conditions in
those foreign markets. Revenues denominated in foreign currencies represented
approximately 15.9% and 22.5% of total revenues for the nine month periods ended
September 30, 2000 and September 30, 1999, respectively. 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 6. EXHIBITS AND REPORTS ON FORM 8-K.
a) Exhibits
10.1 Contract of Employment between eLoyalty (UK) Limited and
Vaughan Thomas, entered into May 12, 2000.*
10.2 eLoyalty Ventures, L.L.C. Operating Agreement dated as of
July 21, 2000, by and among Brookside Capital Partners Fund
LP, Sutter Hill Ventures L.P., TCV IV, L.P. and TCV
Strategic Partners IV, L.P. and eLoyalty Employee Investors,
L.L.C.
10.3 Promissory Note dated May 12, 2000 between eLoyalty (UK)
Limited and Vaughan Thomas.*
27.1 Financial Data Schedule
- --------------------------------------------------------------------------------
*Represents a management contract or a compensatory plan or arrangement
b) Reports on Form 8-K
Not applicable.
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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 November 14, 2000.
eLOYALTY CORPORATION
By /s/ TIMOTHY J. CUNNINGHAM
-----------------------------------------
Timothy J. Cunningham
Senior Vice President and Chief
Financial Officer (Duly authorized
signatory and principal financial officer)
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EXHIBIT INDEX
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- ------ -------------------
10.1 Contract of Employment between eLoyalty (UK) Limited and Vaughan
Thomas, entered into May 12, 2000.*
10.2 eLoyalty Ventures, L.L.C. Operating Agreement dated as of
July 21, 2000, by and among Brookside Capital Partners Fund LP,
Sutter Hill Ventures L.P., TCV IV, L.P. and TCV Strategic Partners
IV, L.P. and eLoyalty Employee Investors, L.L.C.
10.3 Promissory Note dated May 12, 2000 between eLoyalty (UK) Limited and
Vaughan Thomas.*
27.1 Financial Data Schedule
- ------------------------------------------------------------------------------
*Represents a management contract or a compensatory plan or arrangement
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