- --------------------------------------------------------------------------------

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 JUNE 30, 2001

[ ] 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)

<Table>

DELAWARE 36-4304577
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
</Table>

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 10, 2001 WAS 51,575,851.

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2

TABLE OF CONTENTS

<Table>
<Caption>
PAGE
----

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements........................................ 1
Item 2. Management's Discussion and Analysis of Financial Condition 8
and Results of Operations.................................
Item 3. Quantitative and Qualitative Disclosures About Market 18
Risk......................................................
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders......... 19
Item 6. Exhibits and Reports on Form 8-K............................ 19
Signatures............................................................. 20
Exhibit Index..........................................................
</Table>
3

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

eLOYALTY CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

<Table>
<Caption>
JUNE 30, DECEMBER 30,
2001 2000
-------- ------------
(UNAUDITED)

ASSETS:
CURRENT ASSETS:
Cash and cash equivalents................................... $ 39,652 $ 41,138
Marketable securities....................................... 9,574 9,902
Receivables (less allowances of $1,944 and $1,605,
respectively)............................................. 39,451 75,886
Deferred income taxes....................................... 6,044 16,301
Prepaid expenses............................................ 2,627 2,935
Refundable income taxes..................................... 9,025 4,619
Other current assets........................................ 1,670 2,915
-------- --------
Total current assets................................. 108,043 153,696
Equipment and leasehold improvements, net................... 18,538 18,784
Goodwill, net............................................... 4,345 6,990
Deferred income taxes....................................... 9,904 2,664
Long-term receivables and other............................. 2,255 2,484
-------- --------
Total assets......................................... $143,085 $184,618
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY:
CURRENT LIABILITIES:
Short-term debt............................................. $ 8,600 $ --
Accounts payable............................................ 5,511 6,880
Accrued compensation and related costs...................... 16,210 19,964
Deferred compensation....................................... 9,519 9,897
Other current liabilities................................... 6,406 7,021
-------- --------
Total current liabilities............................ 46,246 43,762
-------- --------
Long term liabilities....................................... 3,072 --
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;
51,661,163 and 49,925,702 shares issued and outstanding
respectively.............................................. 517 499
Additional paid-in capital.................................. 147,542 144,860
(Accumulated deficit) retained earnings..................... (44,219) 2,171
Other....................................................... (10,073) (6,674)
-------- --------
Total stockholders' equity........................... 93,767 140,856
-------- --------
Total liabilities and stockholders' equity........... $143,085 $184,618
======== ========
</Table>

The accompanying Notes to Condensed Consolidated Financial Statements
are an integral part of this financial information.

1
4

eLOYALTY CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<Table>
<Caption>
FOR THE FOR THE
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -------------------
2001 2000 2001 2000
---- ---- ---- ----
(UNAUDITED) (UNAUDITED)

Revenues.............................................. $ 34,981 $50,960 $ 81,227 $97,139
Project personnel costs............................. 22,531 24,908 51,098 46,089
-------- ------- -------- -------
Gross profit.......................................... 12,450 26,052 30,129 51,050
-------- ------- -------- -------
Other costs and expenses:
Selling, general and administrative................. 20,466 22,512 50,047 44,370
Severance and related costs......................... 10,719 -- 22,194 --
Research and development............................ 2,121 2,300 4,616 4,328
Goodwill amortization............................... 1,241 1,242 2,485 2,488
-------- ------- -------- -------
34,547 26,054 79,342 51,186
-------- ------- -------- -------
Operating (loss)...................................... (22,097) (2) (49,213) (136)
Other net income...................................... 692 815 1,232 1,261
-------- ------- -------- -------
(Loss) income before income taxes..................... (21,405) 813 (47,981) 1,125
Income tax provision (benefit)........................ 8,508 407 (1,591) 563
-------- ------- -------- -------
Net (loss) income..................................... $(29,913) $ 406 $(46,390) $ 562
======== ======= ======== =======
Net (loss) income per share:
Basic............................................... $ (0.60) $ 0.01 $ (0.93) $ 0.01
======== ======= ======== =======
Diluted............................................. $ (0.60) $ 0.01 $ (0.93) $ 0.01
======== ======= ======== =======
Shares used to calculate basic net (loss) income per
common share........................................ 49,979 47,850 49,964 46,875
======== ======= ======== =======
Shares used to calculate diluted net (loss) income per
common share........................................ 49,979 53,134 49,964 52,618
======== ======= ======== =======
</Table>

The accompanying Notes to Condensed Consolidated Financial Statements
are an integral part of this financial information.

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5

eLOYALTY CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

<Table>
<Caption>
FOR THE
SIX MONTHS
ENDED
JUNE 30,
-------------------
2001 2000
---- ----
(UNAUDITED)

CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income...................................... $(46,390) $ 562
Adjustments to reconcile net (loss) income to net cash
used in operating activities:
Depreciation and amortization..................... 6,034 3,230
Provision for uncollectible amounts............... 2,908 (61)
Severance and related costs....................... 22,194 --
Deferred income taxes............................. 2,624 (5,118)
Changes in assets and liabilities:
Receivables....................................... 32,547 (8,144)
Sales (purchases) of trading securities related to
deferred compensation program.................... 328 (2,085)
Other current assets.............................. (4,477) (1,250)
Accounts payable.................................. (1,330) 4,750
Accrued compensation and related costs............ (15,036) 4,778
Deferred compensation funds from employees........ (378) 2,085
Other current liabilities......................... (7,373) 4,132
Other long-term assets............................ 224 (876)
Long term liabilities............................. 3,072 --
-------- -------
Net cash (used in) provided by operating
activities.................................. (5,053) 2,003
-------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures................................... (5,527) (5,792)
-------- -------
Net cash used in investing activities........ (5,527) (5,792)
-------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from revolving credit agreement............... 9,000 --
Repayments on revolving credit agreement............... (400) --
Proceeds from stock compensation plans................. 1,022 6,164
Proceeds from issuance of common stock................. -- 34,817
Capital contribution from Technology Solutions
Company............................................... -- 20,000
Net advances from Technology Solutions Company......... -- 4,565
-------- -------
Net cash provided by financing activities.... 9,622 65,546
-------- -------
Effect of exchange rate changes on cash and cash
equivalents............................................... (528) (1,749)
-------- -------
(Decrease) increase in cash and cash equivalents............ (1,486) 60,008
Cash and cash equivalents, beginning of period.............. 41,138 13,462
-------- -------
Cash and cash equivalents, end of period.................... $ 39,652 $73,470
======== =======
</Table>

The accompanying Notes to Condensed Consolidated Financial Statements
are an integral part of this financial information.

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6

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 (we or eLoyalty)
include all normal and recurring adjustments necessary for a fair presentation
of our consolidated financial position as of June 30, 2001, the consolidated
results of our operations for the three months and six months ended June 30,
2001 and 2000, and our cash flows for the six months ended June 30, 2001 and
2000, 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 we operated within Technology Solutions Company (TSC),
and subsequent to February 15, 2000, when we operated as a separate, publicly
traded company. Certain reclassifications have been made to the second quarter
and year-to-date 2000 condensed consolidated statement of operations to conform
to the 2001 presentation.

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 consolidated financial
statements and the notes thereto in the Company's Annual Report on Form 10-K for
the fiscal year ended December 30, 2000.

NOTE 2 -- COMPREHENSIVE NET LOSS

Comprehensive net loss is comprised of the following:

<Table>
<Caption>
FOR THE THREE FOR THE SIX
MONTHS ENDED MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -------------------
2001 2000 2001 2000
---- ---- ---- ----
(UNAUDITED) (UNAUDITED)

Net (loss) income..................................... $(29,913) $ 406 $(46,390) $ 562
Other comprehensive loss:
Effect of currency translation...................... (287) (1,158) (2,242) (2,557)
-------- ------- -------- -------
Comprehensive net loss................................ $(30,200) $ (752) $(48,632) $(1,995)
======== ======= ======== =======
</Table>

The accumulated other comprehensive loss, which represents the cumulative
effect of foreign currency translation adjustments, was $4.2 million at June 30,
2001 and $2.0 million at December 30, 2000.

NOTE 3 -- (LOSS) EARNINGS PER SHARE

The following table sets forth the computation of the shares used in the
calculation of our basic and diluted (loss) earnings per share:

<Table>
<Caption>
FOR THE THREE FOR THE SIX
MONTHS ENDED MONTHS ENDED
JUNE 30, JUNE 30,
------------------ ---------------------
2001 2000 2001 2000
---- ---- ---- ----
(UNAUDITED) (UNAUDITED)

Weighted average common shares outstanding............... 49,979 47,850 49,964 46,875
Common stock equivalents................................. 591 5,284 1,562 5,743
------ ------ ------ ------
Weighted average common and common share equivalents..... 50,570 53,134 51,526 52,618
====== ====== ====== ======
</Table>

In periods in which there is a loss, we do not include common stock
equivalents in the diluted (loss) earnings per share calculation as they are
anti-dilutive.

4
7
eLOYALTY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

NOTE 4 -- SEGMENT INFORMATION

We operate in one business segment focused exclusively on providing
customer relationship management ("CRM") related consulting services. Beginning
in 2001 as a result of organizational changes, we have two reportable geographic
segments. Those segments are: North America and International. Our North
American business includes our United States and Canadian operations. Our
International business includes operations in Europe and Australia. The
following table reflects revenues, operating results, and total assets by
reportable segment for the three months and six months ended June 30, 2001 and
June 30, 2000, respectively.

<Table>
<Caption>
FOR THE THREE MONTHS ENDED NORTH
JUNE 30, (UNAUDITED) AMERICA INTERNATIONAL TOTAL
-------------------------- ------- ------------- -----

Revenues
2001...................................................... $ 29,862 $ 5,119 $ 34,981
2000...................................................... $ 45,402 $ 5,558 $ 50,960
Operating income (loss)
2001...................................................... $(14,472) $ (7,625) $(22,097)
2000...................................................... $ 3,746 $ (3,748) $ (2)
</Table>

<Table>
<Caption>
FOR THE SIX MONTHS ENDED NORTH
JUNE 30, (UNAUDITED) AMERICA INTERNATIONAL TOTAL
------------------------ ------- ------------- -----

Revenues
2001...................................................... $ 66,513 $ 14,714 $ 81,227
2000...................................................... $ 87,146 $ 9,993 $ 97,139
Operating income (loss)
2001...................................................... $(37,882) $(11,331) $(49,213)
2000...................................................... $ 8,262 $ (8,398) $ (136)
</Table>

<Table>
<Caption>
NORTH
AS OF JUNE 30, (UNAUDITED) AMERICA INTERNATIONAL TOTAL
- -------------------------- ------- ------------- -----

Total assets
2001...................................................... $126,589 $ 16,496 $143,085
2000...................................................... $154,185 $ 21,490 $175,675
</Table>

NOTE 5 -- SEVERANCE AND RELATED COSTS

We recognized a $10.7 million pre-tax charge in the second quarter of 2001
as a result of cost reduction actions taken in the second quarter. This is in
addition to the $11.5 million charge taken in the first quarter of 2001. These
charges relate to employee severance payments and related costs for
approximately 250 employees, primarily in the North American segment. They also
relate to the closure and downsizing of various offices. Severance costs include
contractual salary and related fringe benefits over the severance payment
period, forgiveness of employee loans and outplacement costs. Facility costs
primarily include expected losses on contractual lease commitments, net of
sublease revenues, and write down of leasehold improvements. Other costs include
laptop and other computer lease termination costs, legal expenses and the write
down of deposits related to outside services, which have been terminated. During
the six months ended June 30, 2001, we made cash payments of $7.4 million and
reduced our headcount by approximately 250 employees related to this cost
reduction action. Of these payments, $5.9 million was expended in the second
quarter of 2001. We expect substantially all severance and related costs to be
paid out by the end of fourth quarter of 2001 pursuant to agreements entered
into with affected employees, and facility costs related to the office closures
to be paid pursuant to contractual lease terms through 2007.

5
8
eLOYALTY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

The following table represents a reconciliation of these charges,
accumulated usage and the reserve balance at June 30, 2001:

<Table>
<Caption>
Q1/Q2 ACCUMULATED RESERVE
CHARGES USAGE BALANCE
------- ----------- -------

Employee severance.......................................... $11,888 $ 7,115 $ 4,773
Facility.................................................... 6,696 2,933 3,763
Other....................................................... 3,610 1,567 2,043
------- ------- -------
Total....................................................... $22,194 $11,615 $10,579
======= ======= =======
</Table>

In addition, on July 31, 2001, we announced an estimated $7.6 million
pre-tax charge to be taken in the third quarter of 2001 relating primarily to
severance benefits associated with a reduction in force affecting approximately
155 employees, which was communicated to affected employees in July. This
additional severance-related charge is expected to be substantially paid out by
the fourth quarter of 2001.

NOTE 6 -- INCOME TAXES

During the second quarter of 2001, we established a $12.2 million valuation
allowance against the benefit of certain international operating unit tax losses
recognized through March 31, 2001 and ceased recording the benefit of losses
incurred by these operating units beginning in the second quarter of fiscal
2001. The decision was made following a company-wide review of potential
financial results by geography under various alternative scenarios and related
assessment and based on relevant accounting guidelines regarding the certainty
of recoverability of these net deferred tax assets in light of the period over
which they arose and the predictability of a near-term return of international
operating units to acceptable, continuing levels of profitability.

We have recorded a deferred tax asset of $15.9 million reflecting primarily
the benefit of U.S. loss carryforwards, which expire in 2020. Realization is
dependant on generating sufficient taxable income in the U.S. prior to
expiration of these loss carryforwards. Although realization is not assured, we
believe that is more likely than not that all of the deferred tax asset will be
realized. The amount of the deferred tax asset considered realizable, however,
could be reduced in the near term if current estimates of the timing and amount
of future taxable income during the carryforward period are significantly
revised.

NOTE 7 -- RESTRICTED STOCK GRANTS

On April 2, 2001, eLoyalty's Board of Directors approved the grant of
1,265,000 shares of restricted stock at a fair market value of $1.75 per share
to certain officers under the eLoyalty Corporation 1999 Stock Incentive Plan.
These shares are subject to a restriction period from the date of grant, during
which the shares may not be sold, assigned, pledged or otherwise encumbered. Of
the 1,265,000 shares granted, 915,000 shares vest over a period of 48 equal
monthly installments beginning May 1, 2001. The remaining 350,000 shares vest in
48 equal monthly installments beginning May 1, 2003.

NOTE 8 -- RECENT ACCOUNTING PRONOUNCEMENTS

In June 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards (SFAS) No. 141, "Business Combinations," and No.
142, "Goodwill and Other Intangible Assets," SFAS No. 141 requires that the
purchase method of accounting be used for all business combinations initiated
after June 30, 2001. SFAS No. 142 eliminates the systematic amortization of
goodwill and indefinite lived intangible assets and requires them to be tested
for impairment at least annually. Separable intangible assets that are not
deemed to have an indefinite life will continue to be amortized over their
useful lives. We

6
9
eLOYALTY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

will adopt SFAS No. 141 effective July 1, 2001 and SFAS No. 142 effective
January 1, 2002. We have not completed an evaluation of the financial statement
effect of adopting SFAS No. 142.

NOTE 9 -- SUBSEQUENT EVENT

We terminated our Executive Deferred Compensation Plan effective as of July
15, 2001, and provided for all participant account balances to be distributed in
a lump sum following the termination effective date. We also terminated an
associated Executive Benefit Trust, effective on completion of distributions
from the plan. This nonqualified deferred compensation plan allowed eligible
participants (employees at or above the level of Vice President) to defer
receipt of a portion of their cash compensation. We expect all distributions
from this plan to be completed before September 30, 2001. Investments purchased
by eLoyalty with the deferred compensation funds and the corresponding
obligations to participants, including investment earnings thereon, are
reflected as assets and liabilities, respectively, on our balance sheet under
the captions "Marketable Securities" and "Deferred Compensation."

7
10

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

FORWARD-LOOKING STATEMENTS

The following Management's Discussion and Analysis and other parts of this
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 noted under "Factors That May Affect Future Results or Market
Price of Stock" included later in this quarterly report. Readers should also
carefully review the risk factors described in other documents eLoyalty files
from time to time with the SEC, including our Annual Report on Form 10-K for the
fiscal year ended December 30, 2000 and our subsequent Quarterly Report on Form
10-Q.

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 eLoyalty undertakes no obligation to publicly update or
revise any forward-looking statements in this report, whether as a result of new
information, or future events or circumstances.

BACKGROUND

eLoyalty is a global management consulting and systems integration
organization focused exclusively on building customer loyalty. eLoyalty has a
broad range of customer relationship management ("CRM") related services
including business strategy, technical architecture, selection, implementation
and integration of appropriate CRM software applications and provision of
ongoing support for multi-vendor systems.

eLoyalty was spun off from Technology Solutions Company ("TSC") into a
separate, publicly traded company on February 15, 2000 (the "spin-off").
Accordingly, the statements of operations for periods subsequent to the spin-off
reflect eLoyalty's results as a stand-alone company. The statements of
operations for periods prior to the spin-off are presented as if eLoyalty
operated as a separate entity, and includes a cost allocation of certain TSC
general corporate expenses that were not directly related to eLoyalty's
operations. These costs were allocated proportionately to eLoyalty based on
revenues and headcount.

PERFORMANCE OVERVIEW AND GENERAL OUTLOOK

Our consolidated revenues were $35.0 million in the second quarter of 2001.
This represents an approximate 31% decline as compared to the second quarter of
2000 and a 24% decline from the first quarter of 2001, which in turn followed a
20% sequential quarterly decline from the fourth quarter of 2000. This second
consecutive sequential quarterly revenue decline followed a period of 45%
revenue growth for fiscal 2000, and returns eLoyalty to its lowest quarterly
revenue level since the second quarter of 1999. As a result, average revenues
per billable day for the second quarter of 2001 were $547,000, down from
$723,000 for the first quarter of 2001 and $945,000 for the fourth quarter of
2000 and lower than the respective averages for fiscal 2000 and 1999. The
sequential quarterly 2001 revenue declines have been primarily attributable to
significant delays and deferrals of new client projects and extensions, which we
believe reflect the impact of broader negative economic conditions on both
client expenditure commitments and client decision time frames for information
technology related projects and consulting services.

We have experienced sequential declines during 2001 in the utilization rate
of our engageable field consultants, partially mitigated by our cost reduction
activities so far this year. Utilization is defined as billed time as a
percentage of total available time. Average utilization was 68%, 66%, 60% and
54% for the second quarter 2000, fiscal year 2000, first quarter 2001, and
second quarter 2001, respectively. Our gross profit margin (gross profits, or
revenues minus project personnel costs, as a percentage of revenues) was 36% for
the second quarter of 2001. This represented a decline from both our 38% gross
profit margin in the first quarter of

8
11

2001 and the 51% gross profit margin achieved for fiscal 2000. We continue to
experience pricing competition similar to that in the first quarter, and our
second quarter average hourly billing rate remained flat at $210 per hour from
the first quarter of 2001. That rate, however, reflected a 10% ($234 to $210)
decline from that in the fourth quarter of 2000, which represented the highest
average quarterly rate achieved during last year.

As previously announced, in early June, Agilent Technologies notified us of
its cancellation of a project on which we and other third parties were engaged.
Agilent had been our single largest customer, contributing approximately $8
million, or 22.8%, of our total revenues for the second quarter of 2001 and
approximately 19% and 15%, respectively, of our total revenues for the first
quarter of 2001 and the prior fiscal year. Given current economic and demand
conditions, this project cancellation is expected to have a material near-term
effect on our revenues, beginning in the third fiscal quarter of this year. In
general, this year as our revenues have declined, demand from prospective new
clients softened and our major account planning focus sharpened, our customer
concentration has grown, increasing our potential exposure to the loss of a
single major customer. During the second quarter of 2001, two clients (in
addition to Agilent) each accounted for more than 10% of our revenues. Our top
20 customers contributed 92% of total revenues for the second quarter of 2001,
as compared to 85% for the first quarter of 2001 and 70% for the second quarter
last fiscal year.

We presently expect the current economic slowdown and resulting uncertain
client expenditure commitments and extended decision time frames to persist
during the remainder of 2001 and to continue into 2002. We are continuing to
experience deferrals of proposed new projects and project extensions at a level
commensurate with the fist quarter of 2001, with pipeline prospects being
converted into firm engagements at a less certain rate and on a longer cycle
than during prior years. In addition, while we expect our North American segment
(which has historically accounted for more than 80% of our consolidated
revenues) to continue to suffer from these adverse conditions, we also have
begun to experience in the second quarter of 2001 some of the same uncertainties
and accompanying demand softness in Europe and other international business
locations. Accordingly, we expect our consolidated revenues for the third
quarter of 2001 to be flat to slightly down from the second quarter, after
excluding the effects of the earlier described project cancellation.

In response to this economic environment and demand slowdown, we have
undertaken a number of cost reduction activities, including headcount reductions
and office closures and downsizing. As a result of those activities, we
recognized a special pre-tax charge of $10.7 million (approximately $7.1 million
after tax) in the second quarter of fiscal 2001. Approximately 75% of this $10.7
million special charge relates to future 2001 cash commitments for agreed
employee severance payments and estimated contractual exit costs associated with
office closures. This second quarter charge is in addition to the special
pre-tax charge of $11.5 million (approximately $7.1 million after-tax) taken in
the first quarter of fiscal 2001.

During July 2001, we initiated further cost reduction actions, including an
additional workforce reduction. We expect that these July actions will result in
an estimated pre-tax special charge of approximately $7.6 million ($5.5 million
after-tax) in the third quarter of fiscal 2001. As a result of these combined
year-to-date actions, we have reduced our overall headcount by approximately
38%, from 1,018 total employees at the end of fiscal 2000 to approximately 630
employees at the end of July 2001. We expect substantially all severance and
related costs to be paid out by the end of this fiscal year pursuant to
agreements entered into with the affected employees and the costs related to the
office closures to be paid pursuant to contract terms through 2007.

During the second quarter of 2001, we established a $12.2 million valuation
allowance against the benefit of certain international operating unit tax losses
recognized through March 31, 2001 and ceased recording the benefit of losses
incurred by these operating units beginning in the second quarter of fiscal
2001. The decision was made following a company-wide review of potential
financial results by geography under various alternative scenarios and a related
assessment, based on relevant accounting guidelines, of the certainty of
recoverability of these net deferred tax assets in light of the period over
which they arose and the predictability of a near-term return of international
operating units to acceptable, continuing levels of profitability.

Primarily as a result of the above-described business conditions and the
responsive cost reduction actions, we experienced a second quarter 2001
operating loss of $22.1 million, compared to essentially break even for the
comparable quarter last fiscal year. The net loss for the second quarter,
including the after-tax effect of the
9
12

special and valuation allowance charges, was $29.9 million, or $ 0.60 per share
on a diluted basis, compared to net income of $0.4 million, or $0.01 per share
on a diluted basis, for the second quarter of 2000.

We intend to closely monitor our pipeline during the ensuing fiscal
quarters and may take additional cost reduction actions based on business demand
and then current economic conditions. In addition, we are evaluating capital
structure and financing alternatives, including among others the possibility of
raising of additional equity capital from existing or new investors, to address
the prospect of a sustained economic downturn and applicable Nasdaq stock market
listing maintenance requirements. See "Liquidity and Capital Resources" below.

RESULTS OF OPERATIONS

SECOND QUARTER 2001 COMPARED WITH SECOND QUARTER 2000

REVENUES

We reported revenues at $35.0 million in the second quarter of 2001 versus
$51.0 million in same quarter last year. Revenues were down, $16 million or 31%,
due to the general economic slowdown and the resulting decrease in technology
investments. 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 occasion, contracted projects on a fixed fee or not-to-exceed
fee basis.

Professional service fee revenues decreased $15.1 million, or 31%, in the
quarter-over-quarter comparison to $33.0 million in the second quarter of 2001
from $48.1 million in the year-ago second quarter. Professional service fee
revenues have also declined in comparison to the last three quarters for which
such revenues were $54.4 million, $54.4 million, and $44.2 million. This
sequential professional service fee revenue decrease in the second quarter of
2001 is believed to be the result of generally reduced spending on information
technology and consulting services.

Other revenue contributors include fees generated from Managed Services
(including Loyalty Support services, purpose-built hosted solutions and
e-PROFILE) and the licensing of proprietary software. Revenues from Managed
Services were $2.0 million, or 6% of second quarter 2001 revenues, and $1.4
million, or 3% of second quarter 2000 revenues. This $0.6 million increase is
the result of increased emphasis on improving recurring revenue streams.
Software revenues decreased $1.5 million to zero in the current-year period
compared to the prior-year period, representing a continuing decline in software
revenues.

North American revenues decreased 34% to $29.9 million in the current year
quarter from $45.4 million in the prior-year quarter. Seven customers accounted
for 76% of the second quarter 2001 North American revenues. In comparison, North
American revenues were $49.6 million, $48.7 million, and $36.6 million,
respectively, for the third and fourth quarters of 2000 and the first quarter of
2001. This sequential decline in revenues is believed due to the continued poor
economic climate described above.

International revenues decreased 9% to $5.1 million in the second quarter
of 2001 from $5.6 million in the second quarter of 2000. International revenues
were $7.2 million, $8.9 million and $9.6 million, respectively, for the third
and fourth quarters of 2000 and the first quarter of 2001. Second quarter 2001
International revenues represent a sequential quarterly decline of 47% from the
first quarter of fiscal 2001, reflecting that our International segment has
begun to experience softening demand due to economic uncertainties like those
prevailing for some time in North America. With our International revenue
declines and key account planning, the result has been an increase in our
International segment's customer concentration. Approximately 80% of
International revenues were derived from four customers during the second
quarter of 2001.

PROJECT PERSONNEL COSTS AND GROSS PROFITS

eLoyalty's most significant operating cost is project personnel costs,
which comprise 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.

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Project personnel costs decreased $2.4 million, or 9.6%, to $22.5 million
in the second quarter of 2001 from $24.9 million in the prior-year second
quarter. The current period decrease in project personnel costs is due in
substantial part to the headcount and other cost reduction actions primarily
affecting our North American operations. (See Severance and related costs
below). As a result of these headcount reductions, the total number of
engageable consultants was 572 at June 30, 2001 compared to approximately 665 at
June 30, 2000. Further headcount reductions occurred in July of 2001, which
resulted in total engageable consultants at July 31, 2001 of approximately 490.

Project personnel costs as a percentage of revenues increased to 64% in the
current year period compared to 49% in the comparable prior-year period,
primarily due to a decline in sales volume and decrease in the utilization of
engageable consultants.

North American project personnel costs decreased to $17.7 million during
the second quarter of 2001 compared to $21.2 million in the prior-year quarter.
As a percentage of revenues, project personnel costs for North America were 59%
in the second quarter of 2001 versus 47% in the prior-year quarter. This is due
to the decline in sales volume and lower utilization in light of the economic
slowdown described above.

International project personnel costs increased to $4.8 million in the
current year quarter from $3.7 million in the prior-year quarter. As a
percentage of revenues, project personnel costs were 94% of revenues in the
second quarter of 2001 versus 67% in the prior year quarter. This is
attributable largely to the same factors as affected our North American project
personnel costs in the second quarter of 2001.

Gross profits represent our revenues less project personnel costs. Our
gross profits have declined in recent years, reflecting in part the adverse
impact of subcontractor use and non-billable time incurred by project personnel.
Gross profit margins also experienced a decline in the second quarter of 2001,
decreasing to 36% from 51% in the second quarter of 2000. Gross profits for
North American operations decreased to $12.2 million in the second quarter of
2001 from $24.2 million in the prior-year second quarter, due primarily to
reduced revenues and lower utilization. International gross profit decreased to
$0.3 million in the current year period from $1.8 million in the prior-year
second quarter period, reflecting lower utilization of engageable consultants in
the second quarter of 2001.

SELLING, GENERAL AND ADMINISTRATIVE

Selling, general and administrative expenses consist primarily of salaries,
incentive compensation and employee benefits for business development,
marketing, managerial and administrative personnel, plus provisions for
uncollectible amounts. Other overhead expenses consist of employee costs for
training, travel expenses, laptop computer leases and other non-billable
expenses not directly related to projects or research and development. For 2000,
this would also include expenses relating to administrative and other support
services provided by TSC as part of a shared services agreement.

Selling, general and administrative expenses decreased $2.0 million, or 9%,
to $20.5 million in the second quarter of 2001 from $22.5 million in the
prior-year quarter. In the second quarter of 2000, we began the build-out of our
infrastructure as a separate company; thus our general and administrative costs
were higher in 2000 reflecting some duplicate costs while we also paid for TSC
shared services. The benefits of our headcount reductions (See Severance and
related costs below) are also reflected in these 2001 results.

SEVERANCE AND RELATED COSTS

We recognized a $10.7 million pre-tax charge in the second quarter of 2001
as a result of cost reduction actions. This also relates to the closure and
downsizing of various offices and certain employee severance benefits relating
to workforce reduction activities communicated to the affected employees in the
second quarter of fiscal 2001. The facility closure costs primarily include
expected losses on contractual lease commitments, net of sublease revenues, and
the write-down of leasehold improvements. Severance costs include contractual
salary and related fringe benefits over the severance payment period,
forgiveness of employee loans and outplacement costs. Other costs include laptop
and other computer equipment lease termination costs, legal expenses and the
write down of deposits related to outside services, which have been

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terminated. This charge was in addition to the $11.5 million charge in the first
quarter of 2001. We expect substantially all severance and related costs to be
paid out by the end of fourth quarter of 2001 pursuant to agreements entered
into with affected employees.

In addition, we announced an estimated $7.6 million pre-tax charge to be
taken in the third quarter of 2001 relating primarily to severance benefits
associated with the employment termination of approximately 155 additional
employees communicated to affected employees in July. The severance related
charges are expected to be paid out by the fourth quarter of 2001. We anticipate
our annualized cost savings from the reduction of salaries, benefits, and
facility lease payments related to all of the above mentioned cost reduction
actions to be $56 million.

RESEARCH AND DEVELOPMENT

Research and development expenses consist primarily of salaries, incentive
compensation and employee benefits for dedicated personnel, staff recruiting
costs, administrative costs, travel expenses and depreciation expenses. Our
Loyalty Lab is the center of our research and development activities, and we
believe it improves the effectiveness of our loyalty solutions, allows us to
work closely with emerging technology and serves as a demonstration center for
our clients.

Research and development expenses decreased $0.2 million, or 9%, to $2.1
million in second quarter of 2001 from $2.3 million in the prior-year quarter,
primarily due to the headcount actions mentioned above.

GOODWILL AMORTIZATION

Goodwill amortization expenses were $1.2 million for both the second
quarter of 2001 and 2000. Goodwill amortization is primarily attributable to the
acquisition of the Bentley Group in 1997.

OPERATING LOSS

We recognized an operating loss of $22.1 million in the second quarter of
2001 compared to essentially break even in the prior-year second quarter. The
current quarter's operating loss is attributable primarily to a special charge
associated with cost reduction actions, reduced revenues and lower utilization
of engageable consultants.

North America had an operating loss of $14.5 million in the second quarter
of 2001 versus operating income of $3.7 million in the second quarter of 2000.
International experienced an operating loss of $7.6 million in the second
quarter of 2001 versus an operating loss of $3.7 million in the second quarter
of 2000. These decreases in operating income are due to reduced revenues, lower
utilization and a special charge as described above.

OTHER INCOME

We recognized non-operating other income of $0.7 million in the second
quarter of 2001 versus $0.8 million in the year ago quarter. Other income
remained flat due to higher investment yields, offset by lower average invested
cash balances and interest paid on short-term debt during the second quarter
2001 compared to the same period in 2000.

INCOME TAX (BENEFIT) PROVISION

We recorded a valuation allowance of $14.4 million relating to our
international deferred tax assets. This reserve is for deferred taxes resulting
from losses prior to March 31, 2001 ($12.2 million) plus additional valuation
allowance of $2.2 million for certain international net operating loss
carryforwards generated in the second quarter of 2001. Due to the recognition of
this valuation allowance, we recognized an income tax provision of $8.5 million
versus a provision of $0.4 million in the second quarter of 2000.

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FIRST SIX MONTHS OF 2001 COMPARED WITH FIRST SIX MONTHS OF 2000

REVENUES

Revenues decreased $15.9 million, or 16%, to $81.2 million in the first six
months of 2001 from $97.1 million in the prior-year period. Professional service
fee revenues decreased $11.9 million in the year-over-year comparison to $77.2
million in 2001 from $89.1 million in the year-ago period. Other revenue
contributors include fees generated from Managed Services (including Loyalty
Support services, purpose-built hosted solutions and e-PROFILE). Revenues from
Managed Services in the first six months of 2001 and 2000 were $3.7 million, or
5% of total 2001 revenues, and $2.8 million, or 3% of total 2000 revenues.
Revenues from software sales decreased $4.8 million to $0.4 million in the
current-year period from $5.2 million in the prior-year period. The $15.9
million decrease in total revenues is believed primarily due to the overall
softening of demand for technology investments as a result of ongoing economic
uncertainties.

North American revenues decreased 24% to $66.5 million in the first six
months of 2001 from $87.1 million in the prior-year period. This general decline
in revenues is believed to result primarily from ongoing economic uncertainties
as described above.

International revenues increased to $14.7 million, or 18.1% of total
revenues, in the first six months of 2001, from $10.0 million, or 10% of total
revenues, in the prior-year period. This increase is due primarily to the fact
that our international segment experienced stronger revenues in the first
quarter of 2001, but did experience a decline in demand due to current economic
uncertainties comparable to that in North America in the second quarter of
fiscal 2001.

PROJECT PERSONNEL COSTS AND GROSS PROFITS

Project personnel costs increased $5.0 million, or 11%, to $51.1 million in
the first six months of 2001 from $46.1 million in the prior-year period. The
current-year increase in project personnel costs is primarily due to a
significant higher level in the number of billable employees in first quarter of
2001, partially offset by headcount reductions made in March and April of 2001.
Project personnel costs as a percentage of revenues increased to 63% in the six
months ended June 30, 2001 compared to 47% in the prior-year period, primarily
due to a 16% revenue decline.

North American project personnel costs increased to $41.8 million during
the six months ended June 30, 2001 compared to $38.3 million in the prior-year
period. As a percentage of revenues, project personnel costs for North America
were 63% in the six months ended June 30, 2001 versus 44% in the prior year
period. The deterioration of these percentages is due to the decline in volume
and lower utilization from the economic slowdown described above.

International project personnel costs increased to $9.3 million for the six
months ended June 30, 2001 versus $7.8 million in the prior-year period. As a
percentage, project personnel costs were 63% of revenues in the six months ended
June 30, 2001 versus 78% in the prior year period. The improvement in this
percentage is due to the headcount reductions mentioned above and increased
revenue in the six months ended June 30, 2001.

SELLING, GENERAL AND ADMINISTRATIVE

Selling, general and administrative expenses increased $5.6 million, or
13%, to $50.0 million in the first six months of 2001 from $44.4 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 group.
General and administrative expenses increased in the period-over-period
comparison, primarily due to the 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, which continued through the second quarter of
2001. Beginning in the first quarter of 2001, we initiated certain cost
reductions as discussed above which resulted in a reduction in our selling,
general and administrative expenses in the second quarter of 2001. However, the
impact did not fully offset the increased expense in the first quarter of 2001
as compared to the first quarter last fiscal year. As a result of the foregoing,
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selling, general and administrative expenses increased as a percentage of
revenues to 62% in the current-year period from 46% in the prior-year period.

SEVERANCE AND RELATED COSTS

We recognized $22.2 million in pre-tax charges in the first six months of
2001 as a result of cost reduction actions taken in the first and second
quarters. These charges relate to severance benefits and the closure and
downsizing of various offices. During the six months ended June 30, 2001, we
made cash payments of $7.4 million and reduced our headcount by approximately
250 employees related to these cost reduction actions. We expect substantially
all severance and related costs to be paid out by the end of fourth quarter of
2001 pursuant to agreements entered into with affected employees and office
closures costs to be paid pursuant to contract terms through 2007.

RESEARCH AND DEVELOPMENT EXPENSES

Research and development expenses increased $0.3 million, or 7%, to $4.6
million in the first six months of 2001 from $4.3 million in the prior-year
period. Research and development expenses increased as a percentage of revenues
from 4.5% in the prior-year period to 5.7% in the current-year period, primarily
due to our increased investment in the first quarter of 2001. This percentage
increase is also the result of the 16% decline in revenues for the comparable
six-month period.

GOODWILL AMORTIZATION

Goodwill amortization expenses remained relatively flat at $2.5 million in
both the first six months of 2001 and 2000, respectively. Goodwill amortization
is primarily attributed to the acquisition of the Bentley Group.

OPERATING LOSS

We recognized an operating loss of $49.2 million for the six months ended
June 30, 2001 compared to an operating loss of $0.1 million in the prior year
period. This incremental operating loss is attributable primarily to the above
described special charges associated with cost reduction actions taken by
management, reduced revenues and lower utilization of engageable consultants.

North America had an operating loss of $37.9 million in the six months
ended June 30, 2001 versus the prior-year period income of $8.3 million.
International experienced an operating loss of $11.3 million for the six months
ended June 30, 2001 versus an operating loss of $8.4 million for the first six
months of 2000. These decreases in operating income are due to reduced revenues,
lower utilization and special charges as described above.

OTHER INCOME

eLoyalty recognized non-operating other income of $1.2 million in the first
six months of 2001 compared to non-operating other income of $1.3 million in the
prior-year period. Other income remained relatively flat due to higher
investment yields, offset by lower average invested cash balances and interest
paid on short term debt during the first six months of 2001 compared to the same
period in 2000.

INCOME TAX (BENEFIT) PROVISION

The benefit from income taxes was $1.6 million in the first six months of
2001 compared to $0.6 million provision in the prior-year period, primarily as a
result of the tax benefits associated with the losses incurred thus far in 2001,
partially offset by the recognition of a second quarter 2001 $14.4 million
valuation allowance related to certain international net operating loss
carryforwards.

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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 support of revenue
generation and growth. Since the spin-off and the associated cessation of
operational funding and cash management support from TSC, we have been dependent
on our own ability to generate capital resources sufficient to meet our ongoing
needs for cash.

Our principal current capital resources consist of our cash and cash
equivalent balances. At June 30, 2001, we had cash and cash equivalents of
approximately $39.7 million, which included the net proceeds of $8.6 million
borrowed under our revolving credit line as of that date (described below).
Excluding the additional cash from these borrowings, our cash and cash
equivalents position declined by approximately $10.0 million in the first six
months of 2001, from $41.1 million at December 30, 2000 to $31.1 million at June
30, 2001.

Net cash of $5.1 million was used by operations for the first six months of
fiscal 2001, compared to $2.0 million of cash provided by operations during the
prior-year period. Our negative operating cash flows in the current-year period
were primarily attributable to the substantial $46.4 million net loss we
sustained for the first six months of 2001, offset by a decrease in receivables
as a result of improved collection efforts and by the inclusion of a total of
$22.2 million of special charges recorded during the period. Approximately $4.8
million of the recorded special charges for the first six months of fiscal 2001
and $5.7 million of the anticipated third quarter charge represents future cash
commitments for employee severance payments that are expected to become payable,
and be charged against cash from operations, in subsequent quarters of fiscal
2001. In addition, $3.6 million of recorded special charges represented future
cash commitments which will become payable and be charged against operating cash
flows in periods 2002 through 2007.

Cash flows used by eLoyalty in investing activities consisted solely of
capital expenditures of $5.5 million for the first six months of fiscal 2001, a
decline of $0.3 million from the $5.8 million of capital expenditures in the
prior-year period. Capital expenditures were higher in the prior-year period,
primarily reflecting the commencement of our fiscal 2000 infrastructure
build-out, including investments in computer hardware and software, furniture,
equipment and leasehold improvements for separate facilities. Total capital
expenditures are expected to approximate $9 million in fiscal 2001, as compared
to $18.6 million during fiscal 2000.

eLoyalty has made an additional commitment to invest up to $14.7 million,
through another newly formed entity, in eLoyalty Ventures, L.L.C. ("eLoyalty
Ventures"). eLoyalty Ventures is a $30 million venture capital fund formed in
2000 by eLoyalty, together with entities associated with Bain Capital, Sutter
Hill Ventures and Technology Crossover Ventures, to focus on investing in
early-stage customer relationship management technology companies. eLoyalty has
not yet been requested to contribute any of its eLoyalty Ventures commitment and
so remains subject to capital calls against that commitment on 10 business days'
prior written notice. We do not expect any capital calls to be made during the
remainder of 2001.

Cash flows provided by financing activities totaled $9.6 million the first
six months of fiscal 2001, a decrease of $55.9 million from the $65.5 million of
cash from financing activities for the same period last year. Of that $9.6
million, $8.6 million was attributable to net borrowings under our revolving
credit facility, repayable not later than December 30, 2001. The balance of the
cash flows from financing activities for the first six months of 2001 related to
proceeds received in connection with stock option exercises and purchases under
the eLoyalty employee stock purchase plan. In comparison, cash flows provided by
financing activities in the first six months of fiscal 2000 included: a $20
million cash contribution from TSC in connection with its spin-off of eLoyalty
on February 15, 2000; proceeds of $34.8 million received from the sale of
eLoyalty common stock to venture capital investors; $6.2 million received from
stock compensation plans; and $4.6 million in net transfers from TSC to fund
operations prior to the spin-off. During fiscal 2000, the increases in
eLoyalty's cash resources were attributable entirely to the $68.3 million in
cash generated during the year from financing activities, the bulk of which
derived from one-time financing events as described above.

Our $8.6 million in net borrowings as of June 30, 2001 was drawn down under
the business loan agreement we entered into with Bank of America, N.A. (the
"Bank") as of December 30, 2000. This loan

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agreement provides for an unsecured revolving line of credit in a maximum
principal amount of $10 million through December 30, 2001 (the "Facility"). As
of June 30, 2001, we had only $0.7 million of credit remaining available for
borrowing under the Facility, as a result of our 2001 net borrowings and four
outstanding letters of credit, totaling $0.7 million, securing office space in
the United States, Europe and Australia.

Among its other financial covenants, the Facility requires us to maintain
$70 million of consolidated tangible net worth. Reserves against assets, such as
the $12.2 million income tax valuation allowance recorded in the second quarter
of fiscal 2001, and operating losses (which reflect the special charges
described above) negatively impact net worth and, accordingly, the tangible net
worth covenant calculation. Due in part to such allowance and operating losses,
our consolidated tangible net worth, as we calculate it for purposes of this
covenant, exceeded the minimum $70 million requirement by approximately $17
million as of June 30, 2001 and by approximately $16 million as of July 28,
2001. As we anticipate a third quarter special charge as described above, we
expect that our tangible net worth (as so calculated) may decline further,
absent offsetting increases to net tangible assets. Accordingly, if current
economic and demand conditions continue to adversely affect our operations, we
may be unable to maintain compliance with this tangible net worth covenant and,
unless we are successful in renegotiating this covenant or obtaining a waiver
from the Bank, we may be required to repay the full amount outstanding under the
Facility before the end of this fiscal year.

In addition, the Facility requires us to maintain unencumbered liquid
assets with an aggregate market value of from 100% to 150% (depending on the
nature of such assets and their location) of the total commitment. Accordingly,
we will be required to maintain at least $10 million in unencumbered liquid
asset coverage throughout 2001 to remain in compliance with this covenant. Other
principal terms of the loan and its covenants are summarized in response to Item
8 of our Form 10-K for the year ended December 30, 2000.

On August 2, 2001, we received a letter from The Nasdaq Stock Market
("Nasdaq") notifying us that we had failed to maintain a minimum closing bid
price of $1.00 over the previous thirty day period, a requirement for continued
Nasdaq listing. The letter further noted that we would be given until October
31, 2001 to restore our compliance with this requirement, by maintaining a
minimum bid price of $1.00 for at least a ten-day period prior to such date. If
we are unable to do so, we will be notified that our securities will be delisted
from Nasdaq. We would have the right to appeal any such decision. Such a
delisting of our common stock would negatively impact its liquidity and, as a
result, may adversely affect our stock price and our ability to raise additional
capital.

We anticipate that our current cash resources should be sufficient to
satisfy our expected working capital and capital expenditure needs for the next
twelve months. Despite our recent cost reduction activities, however, continuing
operating and net losses or adverse impacts on our accounts receivable
collection activities resulting from uncertain prevailing economic conditions
and project deferrals could require us to accelerate use of existing cash
balances to fund operations for the next twelve months and limit our ability to
fund capital and other discretionary expenditures. If our operating activities
or net cash needs for the year were to differ materially from current
expectations, there could be no assurance, given current market, credit and
general economic uncertainties, that we would have access to additional capital
resources on acceptable terms. As noted above under "Performance Overview and
General Outlook," we are currently evaluating various capital structure and
financing alternatives, including potential equity capital financing from
existing or new investors.

YEAR 2000 CONSIDERATIONS

eLoyalty knows of no significant Year 2000 related failures that have
affected eLoyalty provided software or services or internal eLoyalty systems.
Due to the large number of software and systems solutions engagements we have
undertaken over the years, there can be no assurance that all such software and
systems will be Year 2000 compliant or that we may not be subject to future
claims as a result.

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RECENT ACCOUNTING PRONOUNCEMENTS

FACTORS THAT MAY AFFECT FUTURE RESULTS OR MARKET PRICE OF STOCK

Some of the factors that may affect our future results or the market price
of our stock and cause or contribute to material differences between actual
results and those reflected in forward-looking statements contained in this
report include the following:

- Uncertainties associated with the attraction of new clients, the
continuation of existing and new engagements with existing clients and
the timing of related client commitments, including potential client
delays or deferrals of new engagements or existing project extensions in
light of prevailing general economic conditions and uncertainties;

- reliance on a relatively small number of customers for a significant
percentage of our revenues, reliance on major suppliers, including CRM
software providers and other alliance partners, and maintenance of good
relations with key business partners;

- management of the risks associated with increasingly complex client
projects in general as well as new services offerings, including risks
relating to the variability and predictability of the number, size,
scope, cost and duration of, and revenues from, client engagements,
unanticipated cancellations or deferrals of client projects or follow-on
phases of engagements in process, collection of billed amounts, shifts
from time and materials-based engagements to alternative pricing or
value-based models and variable employee utilization rates, project
personnel costs and project requirements;

- management of growth, expansion into new geographic and market areas and
development and introduction of new services offerings, including the
timely and cost-effective implementation of enhanced operating, financial
and other infrastructure systems and procedures;

- challenges in attracting, training, motivating and retaining highly
skilled management, strategic, technical, product development and other
professional employees in a competitive information technology labor
market;

- continuing intense competition in the information technology services
industry generally and, in particular, among those focusing on the
provision of CRM services and software, including both firms with
significantly greater financial and technical resources than eLoyalty and
new entrants;

- the rapid pace of technological innovation in the information technology
services industry, including frequent technological advances and new
product introductions and enhancements, and the ability to create
innovative and adaptable solutions that are consistent with evolving
standards and responsive to client needs, preferences and expectations;

- access in tightened capital and credit markets to sufficient debt and/or
equity capital on acceptable terms to meet our future operating and
financial needs, and uncertainties relating to our future ability to
maintain compliance with existing net worth and liquid asset coverage and
other covenants under our current bank revolving credit agreement or
negotiate acceptable alternative terms or waivers;

- uncertainties regarding both the return and maintenance of our stock
price at a higher minimum bid price level sufficient to maintain our
Nasdaq Stock Market listing and the effectiveness of any actions we may
take to address the same;

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- protection of our technology, proprietary information and other
intellectual property rights or challenges to our intellectual property
by third parties;

- future legislative or regulatory actions relating to the information
technology or information technology services industries including those
relating to data privacy;

- maintenance of our reputation and expansion of our name recognition in
the marketplace;

- risks associated with global operations, including those relating to the
economic conditions in each country, potential currency exchange and
credit volatility, compliance with a variety of foreign laws and
regulations and management of a geographically dispersed organization;

- the overall demand for CRM services and software and information
technology consulting services generally; and

- the continued impact of the current economic slowdown, as well as other
future general business, capital market and economic conditions and
volatility.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We provide solutions to clients in a number of countries including the
United States, Canada, United Kingdom, Germany, France and Australia. For the
quarters ended June 30, 2001 and 2000, 18% and 16%, respectively, of our
revenues were denominated in foreign currencies. Historically, we have not
experienced material fluctuations in our results of operations due to foreign
currency exchange rate changes. However, we believe that an increasing portion
of revenues and costs will be denominated in foreign currencies in the future.
As a result of our exposure to foreign currencies, future financial results
could be affected by factors such as changes in foreign currency exchange rates
or weak economic conditions in those foreign markets.

We also have interest rate risk with respect to changes in variable rate
interest on our revolving line of credit. Interest on the line of credit is
based on IBOR which varies in accordance with prevailing market conditions. A
change in interest rate impacts the interest expense on the line of credit and
cash flows, but does not impact the fair value of the debt.

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PART II. OTHER INFORMATION

ITEM 4 -- SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Our 2001 Annual Meeting of Stockholders (the "Annual Meeting") was held on
May 3, 2001. 44,654,216 shares of eLoyalty common stock were represented at the
Annual Meeting, in person or by proxy. This represented more than a majority of
the shares of eLoyalty common stock outstanding on the record date for the
Annual Meeting and therefore constituted a quorum. Each share present was
entitled to one vote.

The following actions were taken at the Annual Meeting:

(1) Jay C. Hoag, the sole nominee for election as a Class II Director
at the Annual Meeting, was reelected by plurality vote to serve as
a member of eLoyalty's Board of Directors for a three-year term
expiring in 2004. 44,487,150 shares, or more than 99% of the
shares voted, were voted in favor of his election and 167,066
votes withheld. By their terms, the terms of office of the
remaining five Directors on the Board continued after the 2001
Annual Meeting. Kelly D. Conway and Michael D. Murray constituted
the Class III Directors, whose scheduled terms of office continue
until eLoyalty's 2002 Annual Meeting of Stockholders. Tench Coxe,
John T. Kohler and John R. Purcell constituted the Class I
Directors, whose scheduled terms of office continue until
eLoyalty's 2003 Annual Meeting of Stockholders. By letter dated
August 9, 2001, Mr. Purcell resigned from the eLoyalty Board of
Directors.

(2) Stockholders approved the amendment of the eLoyalty Corporation
1999 Employee Stock Purchase Plan to increase the number of shares
of common stock available for purchase under the plan from 500,000
to 1,250,000 shares. 43,239,942 shares, or nearly 97% of the
shares present, were voted in favor of the amendment, 1,404,800
shares were voted against it and there were 9,474 abstentions and
no broker non-votes.

(3) Stockholders ratified the appointment of PricewaterhouseCoopers
LLP as eLoyalty's independent public accountants for its current
fiscal year ending December 29, 2001. The vote was: 44,583,376
shares voted for ratification of such appointment; 68,204 shares
voted against it; and 2,636 shares abstaining from voting. There
were no broker non-votes.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.

a) Exhibits

<Table>

10.1 Employment Agreement, effective June 1, 2001, between Steven
C. Pollema and eLoyalty.*
10.2 Promissory Note, dated June 1, 2001, Steven C. Pollema in
favor of eLoyalty.*
10.3 Indemnification Agreement, dated June 11, 2001, between
Steven C. Pollema and eLoyalty.*
</Table>

- -------------------------
* Represents a management contract or a compensatory plan or arrangement.

b) Reports on Form 8-K

eLoyalty did not file any Current Reports on Form 8-K during the second
quarter of 2001.

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22

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, 2001.

eLOYALTY CORPORATION

By /s/ TIMOTHY J. CUNNINGHAM
------------------------------------
Senior Vice President, Chief
Financial Officer
and Corporate Secretary
(Duly authorized signatory and
principal financial officer)

20
23

EXHIBIT INDEX

<Table>
<Caption>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- ------- -------------------

Employment Agreement, effective June 1, 2001, between Steven
10.1 C. Pollema and eLoyalty.*
Promissory Note, dated June 1 2001, Steven C. Pollema in
10.2 favor of eLoyalty.*
Indemnification Agreement, dated June 11, 2001, between
10.3 Steven C. Pollema and eLoyalty.*
</Table>

- -------------------------
* Represents a management contract or a compensatory plan or arrangement.