ELOYALTY CORP - 10-Q Quarterly Report

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 28, 2003

	OR

o	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 o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes o No x

The number of outstanding shares of the registrant’s common stock, $0.01 par value per share, as of August 8, 2003 was 7,014,059.

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 4. Submission of Matters to a Vote of Security Holders
	Item 6. Exhibits and Reports on Form 8-K.
	SIGNATURES
EX-10.1 Amendment No. 5 to Loan Agreement
EX-31.1 Certification Under Section 302
EX-31.2 Certification Under Section 302
EX-32.1 Certification Under Section 906

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	8
	Item 3.	Qualitative and Quantitative Disclosures About Market Risk	18
	Item 4.	Controls and Procedures	18

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

Part I. Financial Information

Item 1. Financial Statements

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


					June 28,			December 28,
					2003			2002

					(unaudited)
				ASSETS:
Current Assets:
	Cash and cash equivalents				$	37,623		$	48,879
	Restricted cash					10,176			9,579
	Receivables (net of allowances of $1,557 and $1,590, respectively)					10,901			10,443
	Prepaid expenses					2,945			1,180
	Refundable income taxes					182			300
	Other current assets					410			467

			Total current assets			62,237			70,848
Equipment and leasehold improvements, net						11,789			13,859
Goodwill and other intangibles, net						2,450			2,135
Long-term receivables and other						1,037			961

			Total assets		$	77,513		$	87,803

				LIABILITIES AND STOCKHOLDERS’ EQUITY:
Current Liabilities:
		Short-term debt			$	8,600		$	8,600
		Accounts payable				1,731			1,668
		Accrued compensation and related costs				4,426			5,902
		Other current liabilities				5,921			6,819

				Total current liabilities		20,678			22,989

Long-term liabilities						1,894			2,358
Commitments and contingencies
Redeemable Series B convertible preferred stock, $0.01 par value; 5,000,000 shares
		authorized and designated; 4,269,570 and 4,343,627 shares issued and outstanding
		with a liquidation preference of $22,529 and $22,915 at
		June 28, 2003 and December 28, 2002, respectively				21,775			22,153
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;
		6,903,776 and 6,752,398 shares issued and outstanding, respectively				69			67
Additional paid-in capital						150,275			150,761
Accumulated deficit						(104,826	)		(96,894	)
Unearned compensation						(8,284	)		(9,480	)
Accumulated other comprehensive loss						(4,068	)		(4,151	)

				Total stockholders’ equity		33,166			40,303

				Total liabilities and stockholders’ equity	$	77,513		$	87,803

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

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


			For the						For the
			Three Months Ended						Six Months Ended
			June						June

			2003			2002			2003			2002

			(unaudited)						(unaudited)
Revenue			$	16,408		$	21,731		$	34,135		$	47,590
Operating Expenses:
	Cost of services			11,927			14,375			25,289			31,183
	Selling, general, administrative and
		research and development		6,335			6,934			13,047			15,020
	Severance and related costs			(149	)		—			1,111			2,410
	Depreciation and amortization expense			1,341			1,387			2,693			2,735

Total operating expenses				19,454			22,696			42,140			51,348

Operating loss				(3,046	)		(965	)		(8,005	)		(3,758	)
Other income, net				78			175			158			481

Loss before income taxes				(2,968	)		(790	)		(7,847	)		(3,277	)
Income tax provision (benefit)				85			185			85			(217	)

Net loss				(3,053	)		(975	)		(7,932	)		(3,060	)
Dividends and accretion related to Series B preferred stock				(373	)		(2,143	)		(771	)		(4,584	)

Net loss available to common stockholders			$	(3,426	)	$	(3,118	)	$	(8,703	)	$	(7,644	)

Basic net loss per common share			$	(0.61	)	$	(0.61	)	$	(1.56	)	$	(1.50	)

Diluted net loss per common share			$	(0.61	)	$	(0.61	)	$	(1.56	)	$	(1.50	)

Shares used to calculate basic net loss per common share				5,619			5,100			5,570			5,081

Shares used to calculate diluted net loss per common share				5,619			5,100			5,570			5,081

Noncash compensation included in individual line items above:
	Cost of services		$	198		$	212		$	410		$	357
	Selling, general, administrative and
		research and development		522			764			1,089			1,284

Total noncash compensation			$	720		$	976		$	1,499		$	1,641

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

eLoyalty Corporation
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)


				For the Six Months
				Ended June

				2003			2002

				(unaudited)
Cash Flows from Operating Activities:
	Net loss			$	(7,932	)	$	(3,060	)
	Adjustments to reconcile net loss to net cash (used in) provided by
		operating activities:
		Depreciation, amortization and noncash compensation			4,192			4,376
		Provision for uncollectible amounts			—			(400	)
		Noncash severance and related costs			—			(2,038	)
		Deferred income taxes			—			501
	Changes in assets and liabilities:
		Receivables			(307	)		6,561
		Refundable income taxes			118			6,984
		Other current assets			(1,862	)		(904	)
		Accounts payable			38			139
		Accrued compensation and related costs			(1,740	)		(1,184	)
		Other liabilities			(1,599	)		(2,921	)
		Long-term receivables and other			31			245

		Net cash (used in) provided by operating activities			(9,061	)		8,299

Cash Flows from Investing Activities:
	Capital expenditures and other				(923	)		(1,452	)

			Net cash used in investing activities		(923	)		(1,452	)

Cash Flows from Financing Activities:
	Proceeds from revolving credit agreement				17,200			—
	Repayments on revolving credit agreement				(17,200	)		—
	Required deposit on revolving credit agreement				(597	)		(1,352	)
	Payment of Series B dividends				(779	)		—
	Proceeds from stock compensation plans				—			89

			Net cash used in financing activities		(1,376	)		(1,263	)

Effect of exchange rate changes on cash and cash equivalents					104			(130	)

(Decrease) increase in cash and cash equivalents					(11,256	)		5,454
Cash and cash equivalents, beginning of period					48,879			42,653

Cash and cash equivalents, end of period				$	37,623		$	48,107

Supplemental Disclosures of Cash Flow Information:
Cash paid for interest				$	(61	)	$	(96	)
Cash refunded for income taxes				$	24		$	6,732

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

eLoyalty Corporation
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except 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 condensed consolidated financial position as of June 28, 2003, the condensed consolidated results of our operations for the three months and six months ended June 28, 2003 and June 29, 2002 and our condensed consolidated cash flows for the six months ended June 28, 2003 and June 29, 2002, and are in conformity with Securities and Exchange Commission (SEC) Rule 10-01 of Regulation S-X.

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 28, 2002.

Note 2 — Severance and related costs

Severance costs are comprised primarily of contractual salary and related fringe benefits over the severance payment period. Facility costs include losses on contractual lease commitments, net of estimated sublease recoveries, and impairment of leasehold improvements and certain office assets. Other costs include laptop costs and other contractual computer lease termination costs, and other employee related expenses.

Included in severance and related costs for the second quarter of 2003 is $416 of severance and related costs associated with the elimination of five positions in both our North American and International operations offset by adjustments of $234 following the favorable resolution of two matters involving former employees, $181 related to realized currency gains from transactions associated with the consolidation of our International operations and $150 related to adjustments of accruals for facility and other costs.

During the six months ended June 28, 2003, eLoyalty made cash payments of $3,322 related to cost reduction actions initiated in 2003 and earlier periods. Annual savings resulting from cost reduction actions initiated in 2003 are expected to be approximately $4,300 and to be fully realized in 2004. eLoyalty expects substantially all severance and other charges to be paid out by the end of 2003 pursuant to agreements entered into with affected employees.

The severance and related costs and their utilization as of the six months ended June 28, 2003 are as follows (in thousands):


	Reserve								Reserve
	Balance		Charges/						Balance
	12-28-02		Adjustments			Payments			6-28-03

Employee severance	$	2,158	$	1,274		$	(2,122	)	$	1,310
Facilities		4,095		(68	)		(801	)		3,226
Other		1,105		(95	)		(399	)		611

Total	$	7,358	$	1,111		$	(3,322	)	$	5,147

Of the $5,147 that remains reserved as of June 28, 2003, $1,894 related to future lease payments, net of estimated sublease recoveries, is recorded in “Long-term liabilities,” $1,310 related to severance payments is recorded in “Accrued compensation and related costs” and the balance of $1,943 is recorded in “Other current liabilities.” Of the balance in “Other current liabilities,” $1,367 relates to lease payments and is expected to be paid over the next twelve months. eLoyalty has adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 146 effective December 29, 2002.

The $801 of facility payments in the six months ended June 28, 2003 related to amounts reserved in 2002 and 2001. Payments for facility costs related to office space reductions and office closures, reserved for in prior years, are to be paid pursuant to contractual lease terms through 2007.

Note 3 — Comprehensive Net Loss

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


		For the Three						For the Six
		Months Ended						Months Ended
		June						June

		2003			2002			2003			2002

		(unaudited)						(unaudited)
Net loss		$	(3,053	)	$	(975	)	$	(7,932	)	$	(3,060	)
Other comprehensive loss:
	Effect of currency translation		49			478			83			290

	Comprehensive net loss	$	(3,004	)	$	(497	)	$	(7,849	)	$	(2,770	)

The

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