ELOYALTY CORP - 10-Q Quarterly Report

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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 28, 2002

[ ] 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 (State or Other Jurisdiction of Incorporation or Organization)		36-4304577 (I.R.S. Employer 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 4, 2002 was 6,489,012.

TABLE OF CONTENTS


Part I. Financial Information
	Item 1. Financial Statements
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3. Qualitative and Quantitative Disclosures about Market Risk
	Item 4. Controls and Procedures
Part II. Other Information
	Item 5. Other.
	Item 6. Exhibits and Reports on Form 8-K.
SIGNATURES
CERTIFICATIONS
Employment Agreement for Kelly D. Conway

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		10
	Item 3. Qualitative and Quantitative Disclosures About Market Risk		21
	Item 4. Controls and Procedures		21
Part II. Other Information
	Item 5. Other		22
	Item 6. Exhibits and Reports on Form 8-K		22
	Signatures		23
	Certifications		24

Part I. Financial Information

Item 1. Financial Statements

eLoyalty Corporation
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)


		September 28,			December 29,
		2002			2001

		(unaudited)
ASSETS:
Current Assets:
Cash and cash equivalents		$	49,134		$	42,653
Restricted cash			10,564			9,448
Receivables (less allowances of $1,590 and $2,400, respectively)			13,363			22,934
Deferred come taxes			2,025			2,451
Prepaid expenses			1,576			1,190
Refundable income taxes			347			6,597
Other current assets			648			2,300

	Total current assets		77,657			87,573
Equipment and leasehold improvements, net			15,735			17,889
Goodwill, net			2,135			2,135
Deferred income taxes			21,015			20,059
Long-term receivables and other			70			358

	Total assets	$	116,612		$	128,014

LIABILITIES AND STOCKHOLDERS’ EQUITY:
Current Liabilities:
Short-term debt		$	8,600		$	8,600
Accounts payable			2,919			2,154
Accrued compensation and related costs			6,468			8,274
Other current liabilities			6,167			8,750

	Total current liabilities		24,154			27,778

Long-term liabilities			2,359			3,390
Commitments and contingencies
Redeemable Series B convertible preferred stock, $0.01 par value; 5,000,000 shares authorized and designated; 4,399,562 and 4,562,372 shares issued and outstanding with a liquidation preference of $22,830 and $23,318 at September 28, 2002 and December 29, 2001, respectively			22,438			19,499
Stockholders’ Equity:
Preferred stock, $0.01 par value; 35,000,000 shares authorized; none issued and outstanding			—			—
Common stock, $0.01 par value; 50,000,000 shares authorized; 6,433,858 and 5,629,218 shares issued and outstanding, respectively			64			56
Additional paid-in capital			150,053			150,071
Accumulated deficit			(68,885	)		(61,490	)
Unearned compensation			(9,344	)		(6,749	)
Other			(4,227	)		(4,541	)

	Total stockholders’ equity		67,661			77,347

	Total liabilities and stockholders’ equity	$	116,612		$	128,014

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


		eLoyalty Corporation
		CONSOLIDATED STATEMENTS OF OPERATIONS
		(In thousands, except per share data)


		For the						For the
		Three Months Ended						Nine Months Ended
		September						September

		2002			2001			2002			2001

		(unaudited)						(unaudited)
Revenue		$	20,730		$	29,129		$	68,320		$	121,083
Operating Expenses:
	Cost of services		14,130			23,425			45,313			95,005
	Selling, general, administrative and research and development		7,131			11,703			22,151			53,767
	Severance and related costs		3,140			7,097			5,550			29,291
	Depreciation expense		1,366			1,398			4,101			4,242
	Goodwill amortization		—			1,123			—			3,608

Total operating expenses			25,767			44,746			77,115			185,913

Operating loss			(5,037	)		(15,617	)		(8,795	)		(64,830	)
Other income (loss)			145			(22	)		626			1,210

Loss before income taxes			(4,892	)		(15,639	)		(8,169	)		(63,620	)
Income tax benefit			(557	)		(5,656	)		(774	)		(7,247	)

Net loss		$	(4,335	)	$	(9,983	)	$	(7,395	)	$	(56,373	)
Dividends and accretion related to Series B preferred stock			(411	)		—			(4,995	)		—

Net loss available to common stockholders		$	(4,746	)	$	(9,983	)	$	(12,390	)	$	(56,373	)

Basic net loss per common share		$	(0.92	)	$	(1.99	)	$	(2.43	)	$	(11.27	)

Diluted net loss per common share		$	(0.92	)	$	(1.99	)	$	(2.43	)	$	(11.27	)

Shares used to calculate basic net loss per common share			5,158			5,013			5,107			5,002

Shares used to calculate diluted net loss per common share			5,158			5,013			5,107			5,002

Noncash compensation included in individual line items above:
	Cost of services	$	279		$	95		$	636		$	725
	Selling, general, administrative and research and development		657			486			1,941			1,530

Total noncash compensation		$	936		$	581		$	2,577		$	2,255

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

eLoyalty Corporation
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)


				For the Nine Months
				Ended September

				2002			2001

						(unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
	Net loss			$	(7,395	)	$	(56,373	)
	Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
		Depreciation, goodwill amortization and noncash compensation			6,678			10,105
		Uncollectible amounts			(400	)		3,891
		Noncash severance and related costs			—			5,179
		Deferred income taxes			(530	)		(1,942	)
	Changes in assets and liabilities:
		Receivables			10,400			46,888
		Sales of trading securities related to deferred compensation program			—			9,902
		Refundable income taxes			6,223			(3,964	)
		Other current assets			485			(4,448	)
		Accounts payable			706			(1,230	)
		Accrued compensation and related costs			(1,918	)		(6,554	)
		Deferred compensation			—			(9,897	)
		Other liabilities			(4,404	)		5,103
		Long-term receivables and other			289			1,776

		Net cash provided by (used in) operating activities			10,134			(1,564	)

CASH FLOWS FROM INVESTING ACTIVITIES:
	Capital expenditures				(1,921	)		(8,927	)

			Net cash used in investing activities		(1,921	)		(8,927	)

CASH FLOWS FROM FINANCING ACTIVITIES:
	Proceeds from revolving credit agreement				—			9,000
	Required deposit on revolving credit agreement				(1,116	)		—
	Payment of Series B dividends				(882	)		—
	Repayments on revolving credit agreement				—			(400	)
	Proceeds from stock compensation plans				89			1,088

			Net cash (used in) provided by financing activities		(1,909	)		9,688

Effect of exchange rate changes on cash and cash equivalents					177			(1,381	)

Increase (decrease) in cash and cash equivalents					6,481			(2,184	)
Cash and cash equivalents, beginning of period					42,653			41,138

Cash and cash equivalents, end of period				$	49,134		$	38,954

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid for interest				$	154		$	194
Cash (refunded) paid for income taxes				$	(6,806	)	$	1,140

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

eLoyalty Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1—General

In the opinion of management, the accompanying unaudited 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 September 28, 2002, the consolidated results of our operations for the three months and nine months ended September 28, 2002 and September 29, 2001, and our consolidated cash flows for the nine months ended September 28, 2002 and September 29, 2001, and are in conformity with Securities and Exchange Commission (SEC) Rule 10-01 of Regulation S-X. Certain reclassifications have been made to the 2001 consolidated statements of operations to conform to the 2002 presentation. These reclassifications had no impact on net loss or stockholders’ equity. All share amounts have been adjusted to give effect to the one-for-ten reverse stock split effected December 19, 2001.

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 our Annual Report on Form 10-K for the fiscal year ended December 29, 2001 and our Form 8-K filed on June 19, 2002.

Note 2—Severance and related costs

eLoyalty recognized pre-tax charges of $3.1 million and $7.1 million for the three months ended September 28, 2002 and September 29, 2001, respectively. The $3.1 million charge in the quarter ended September 28, 2002, was primarily related to employee severance payments and other costs for the elimination of approximately 50 positions, in both the North American and International segments. The $7.1 million charge for the three months ended September 29, 2001 included employee severance payments for approximately 160 employees and related facility costs. For the nine months ended September 28, 2002 and September 29, 2001, the pre-tax charge was $5.6 million and $29.3 million, respectively. The charges in the nine months ended September 28, 2002 are primarily related to employee severance payments and related facility costs, while the charges in the nine months ended September 29, 2001 are for employee severance payments in the North American and International segments as well as facility and other costs.

Severance costs include contractual salary and related fringe benefits over the severance payment period and outplacement costs. Facility costs primarily include expected losses on contractual lease commitments, net of estimated sublease recoveries, and write down of leasehold improvements. Other costs include laptop and other computer lease termination costs, legal expenses and, in 2001, the write down of deposits related to outside services, which have been terminated.

During the nine months ended September 28, 2002, eLoyalty made cash payments of $6.6 million related to the foregoing actions. Substantially all of the employees affected by these actions have been terminated as of September 28, 2002. eLoyalty expects substantially all severance costs to be paid out by March 2003 pursuant to agreements entered into with affected employees, facility costs related to the office closures to be paid pursuant to contractual lease terms through 2007 and other costs to be paid pursuant to contractual commitments through 2003.

The following table represents the activity related to these charges for the nine months ended September 28, 2002 (in thousands):


	Reserve Balance		Charges and				Reserve Balance
	December 29, 2001		Adjustments		Payments		September 28, 2002

Employee severance	$	1,601	$	4,332	$	3,743	$	2,190
Facilities		4,141		420		1,166		3,395
Other		2,174		798		1,687		1,285

Total	$	7,916	$	5,550	$	6,596	$	6,870

The remaining reserve for facilities reflects an estimate of costs for closed facilities for which subletting is not expected to result in the full recovery of our total contracted lease payments. If we are unable to sublet any of these facilities, the additional charge would be approximately $0.9 million. The charges and adjustments during the nine months ended September 28, 2002 reflect a total charge of $4.8 million for employee severance and related costs and changes in estimates of prior accruals of $0.8 million for leases and severances.

Of the $6.9 million that remains reserved as of September 28, 2002, $2.4 million related to future lease payments, net of estimated sublease recoveries, is reflected in Long-term liabilities, $2.1 million related to severance payments is reflected in Accrued compensation and related costs and the balance of $2.4 million is reflected in Other current liabilities.

Note 3—Comprehensive Net Loss

Comprehensive net loss is comprised of the following (in thousands):


		For the Three							For the Nine
		Months Ended							Months Ended
		September							September

		2002				2001			2002			2001

		(unaudited)							(unaudited)
Net loss		$	(4,335	)		$	(9,983	)	$	(7,395	)	$	(56,373	)
Other comprehensive loss:
	Effect of currency translation		24				106			314			(2,136	)

Comprehensive net loss		$	(4,311	)		$	(9,877	)	$	(7,081	)	$	(58,509	)
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