-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, HEWR+NPH8gOeupXhCG8nOFBKOVhuDmFLhKZkrgSfF9rshHUHx5OpGcxlE0xiR2Ej TZllnWvZozej2qzD3phmLg== 0000950137-00-001479.txt : 20000331 0000950137-00-001479.hdr.sgml : 20000331 ACCESSION NUMBER: 0000950137-00-001479 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ELOYALTY CORP CENTRAL INDEX KEY: 0001094348 STANDARD INDUSTRIAL CLASSIFICATION: [9995] IRS NUMBER: 364304577 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-27975 FILM NUMBER: 589055 BUSINESS ADDRESS: STREET 1: 205 NORTH MICHIGAN AVENUE, SUITE 1500 CITY: CHICAGO STATE: IL ZIP: 60601 BUSINESS PHONE: 3122284500 MAIL ADDRESS: STREET 1: 205 NORTH MICHIGAN AVENUE, SUITE 1500 CITY: CHICAGO STATE: IL ZIP: 60601 10-K405 1 FORM 10-K405 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 --------------------- FORM 10-K (MARK ONE) (X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE YEAR ENDED DECEMBER 31, 1999 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO ______ COMMISSION FILE NUMBER ________ eLOYALTY CORPORATION (Exact Name of Registrant as Specified in Its Charter) DELAWARE 7373 36-4304577 (State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer Incorporation or organization) Classification Code Number) Identification No.)
205 NORTH MICHIGAN AVENUE SUITE 1500 CHICAGO, ILLINOIS 60601 (312) 228-4500 (Address, including zip code and telephone number, including area code, of Registrant's principal executive offices) --------------------- SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NAME OF EACH EXCHANGE TITLE OF EACH CLASS ON WHICH REGISTERED COMMON STOCK, $.01 PER SHARE NASDAQ 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_ NO X INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM 405 OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED, TO THE BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION STATEMENTS INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K OR ANY AMENDMENT TO THIS FORM 10K [ X ] THE AGGREGATE MARKET VALUE OF COMMON STOCK HELD BY NON-AFFILIATES OF THE REGISTRANT AS OF MARCH 24, 2000 WAS (BASED UPON THE PER SHARE CLOSING PRICE OF $30.8125 ON MARCH 24, 2000, AND, FOR THE PURPOSE OF THIS CALCULATION ONLY, THE ASSUMPTION THAT ALL REGISTRANT'S DIRECTORS AND EXECUTIVE OFFICERS ARE AFFILIATES) WAS APPROXIMATELY $1,315,000,000. THE NUMBER OF SHARES OUTSTANDING OF THE REGISTRANT'S COMMON STOCK, $.01 PAR VALUE PER SHARE AS OF MARCH 24, 2000 WAS 46,955,678. DOCUMENTS INCORPORATED BY REFERENCE CERTAIN EXHIBITS LISTED IN THIS ANNUAL REPORT ON FORM 10-K ARE INCORPORATED BY REFERENCE FROM PRIOR FILINGS MADE BY THE REGISTRANT UNDER THE SECURITIES ACT OF 1933. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 TABLE OF CONTENTS
PAGE ---- PART I Item 1. Business........................................ 1 Item 2. Properties...................................... 16 Item 3. Legal Proceedings............................... 16 Item 4. Submission of Matters to a Vote of Security Holders................................................ 16 PART II. Item 5. Market for the Registrants' Common Equity and Related Stockholder Matters..................... 17 Item 6. Selected Financial Data......................... 17 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations... 19 Item 8. Financial Statements and Supplementary Data..... 28 Item 9. Charges in and Disagreements with Accountants on Accounting and Financial Disclosure............. 49 PART III. Item 10. Directors and Executive Officers of the Registrant...................................... 49 Item 11. Executive Compensation.......................... 53 Item 12. Security Ownership of Certain Beneficial Owners and Management.................................. 56 Item 13. Certain Relationships and Related Transactions.................................... 58 PART IV. Item 14. Exhibits, Financial Statements Schedules and Reports on 8K................................... 62
i 3 PART I ITEM 1. BUSINESS This Annual Report on Form 10-K ("Form 10-K") contains forward-looking statements that involve risks and uncertainties. You should not rely on these forward-looking statements. We use words such as "anticipate," "believe," "plan," "expect," "future," "intend" and similar expressions to identify such forward-looking statements. This Form 10-K also contains forward-looking statements attributed to third parties relating to their estimates regarding, among other things, the growth of the customer relationship management or CRM industry and the number of Internet users. You should not place undue reliance on those forward-looking statements. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including the risks faced by us described below and elsewhere in this Form 10-K. INTRODUCTION eLoyalty Corporation (together with its subsidiaries "eLoyalty," "we" or the "Company") was incorporated as a Delaware corporation in May 1999. The Company was founded in May 1994 as a call center business unit within Technology Solutions Company. To reflect the broader scope and strategic, enterprise-wide focus of the solutions developed and offered by the group, it was renamed the Enterprise Customer Management business unit in 1997. In June 1999, the Enterprise Customer Management business unit was named the eLoyalty division of Technology Solutions Company. Since 1994, this group within Technology Solutions Company has consistently dedicated time and resources to developing eLoyalty's strategic consulting and technology capabilities in an effort to lead the development of, and stay at the forefront of, the electronic customer relationship management or eCRM market. In February 2000 the Board of Directors of Technology Solutions approved a spin-off of a separate company comprised of substantially all of the businesses previously operated within the Customer Relationship Management (CRM) group. To effectuate the transaction, the Board of Directors of Technology Solutions Company declared a dividend payable to the holders of record of Technology Solutions Company as of February 9, 2000, based upon a ratio of one share of, the Company's common stock, par value of $.01 per share (the "Common Stock") for every one share of Technology Solutions Common Stock owned on the record date. Effective February 15, 2000 (the "Distribution Date") all of the outstanding shares of Common Stock were distributed to Technology Solutions Company stockholders. OVERVIEW We are a management consulting and information technology services company providing solutions that are designed to improve customer relationships for our clients. We define these solutions as loyalty solutions. We believe that loyalty solutions are the next step in the CRM market. The CRM market refers to consulting services and software products designed to help companies better communicate with their customers. The CRM market focuses primarily on the person to person (for instance through field sales and field service) and telephone (for instance through call center) as the means of communication. With the emergence of the Internet, managing customer relationships has become more complex. The Internet is available at all times of the day and night and almost anywhere in the world. This freedom of access can create an expectation with customers that they should be able to communicate with any part of a company about any matter relating to their products or services at any time. To meet these new expectations, a company needs to link the policies and technologies of their existing CRM solution into this new electronic environment. We define the market opportunity created by this business need as eCRM. eCRM is an expansion of CRM to further include the Internet, e-mail and web-chat across each division of a company. Our key services to build a loyalty solution include: - strategic and business consulting to define a company's policy for managing customer relationships; - technical knowledge of the software products available from third party vendors in this area; 1 4 - proprietary software and methodologies to tie together the different software products; and - ongoing support to meet the changing business requirements of our clients as well as to update their solutions as technology advances. 2 5 The following scenarios illustrate how loyalty solutions can increase profitability and build loyalty: CUSTOMER SCENARIO #1: BANKING A highly valued customer is late making his credit card payment. He has exceeded his credit limit and is about to have his credit line suspended. The bank's standard policy on late payments is to charge a $20 delinquency fee and to apply a high interest charge to the outstanding balance. A customer information database identifies the situation and notes that although he is a low value customer to the credit card division, he is of high overall value to the bank because he maintains several profitable accounts. In recognition of his value, the business rules put into place by executive management and embedded in the loyalty solution direct the customer service representative to initiate a call to the customer and notify him that he has been granted a two-week payment extension and that no fees or interest will be charged to his account. To increase the profitability of this relationship, the loyalty solution also prompts the customer service representative to up-sell the customer a new platinum credit card. The customer accepts the offer because his credit limit will be increased. The bank expects to generate higher annual fees from this upgrade as well as greater transaction revenue from the customer's increased spending. CUSTOMER SCENARIO #2: TECHNOLOGY A highly valued customer has purchased many top-of-the-line computers from the direct sales division over the past two years. The customer has recently experienced a problem with a new printer only four months after buying it. Unfortunately, the customer did not purchase an extended warranty. The company's standard policy is to charge a fee to repair the machine after the standard, ninety-day coverage expires. The customer goes on-line, but cannot find the solution to the printer's problem using the self-service problem resolution application on the company's web site. The loyalty solution recognizes the customer's value and automatically presents the customer with a "call me" option. Within minutes, the customer receives a call at home from a technical engineer. The engineer quickly determines that the printer does not have sufficient memory to meet the customer's needs. Information pulled from the customer database by the loyalty solution also notifies the engineer that during the customer's previous on-line activity he has been browsing the scanner section of the company's web site. The engineer then informs the customer that he will not be charged for the service request and successfully sells the customer an upgrade package for the printer along with a new order for a scanner at a special discounted rate. CUSTOMER SCENARIO #3: TRAVEL A top-tier business traveler is making an on-line reservation to fly with her husband and daughter on vacation. The executive travels over 100,000 miles a year with the airline, putting her in the top group of frequent fliers. She has collected sufficient points to upgrade her family on this trip, however, the airline's standard travel policy allows only one additional upgrade per reservation. This would mean that one of the three passengers has to travel alone in coach class seating. This same businesswoman is also the decision maker for her company's travel policy. The Internet ticketing system automatically searches the customer information database and determines that the customer is in the airline's highest value segment. Based on business rules put into place by executive management, the Internet ticketing system allows the high-value customer to upgrade up to three additional reservations. These rules, embedded in the loyalty solution, direct the system to offer the businesswoman a "companion travels free" coupon as an incentive for her to use the airline for subsequent personal travel. 3 6 INDUSTRY BACKGROUND Increasing competitiveness is forcing companies to become more focused on their current customers. The importance of customer relationships is a familiar business concept. New technologies are helping companies attract and maximize the value of their existing customers more effectively. In addition, the rapid growth of the Internet is fundamentally changing the way businesses communicate (interact) with their customers. Customers can use the Internet to more quickly evaluate products and prices from a wide range of companies without regard to geographical constraints. Consumers are increasingly using the Internet, e-mail and web-chat as their preferred methods of communication. International Data Corporation (IDC) expects the number of worldwide Internet users to grow from 142 million in 1998 to 502 million in 2003. In addition, IDC expects consumer e-mail users in the United States to grow from 48 million in 1998 to 112 million in 2005. To remain competitive in this dynamic business environment, more companies are seeking to create and enhance customer loyalty by making their interactions with customers more personal and relevant to the customer. By personalizing these contacts with their customers, companies hope to build a stronger relationship with each customer -- a relationship that will increase that customer's loyalty to the company's products or services. This greater loyalty is expected to increase revenue and profitability per customer. By knowing their customers better, companies can market complementary products, known as "cross-selling," or market higher-end products, known as "up-selling," during regular customer interactions. Furthermore, companies today are increasingly aware of the significant financial impact associated with losing high value customers, particularly in the early stages of the relationship. In most industries, initial customer acquisition costs far exceed a typical customer's spending in the first year. According to research presented by Frederick R. Reichheld and W. Earl Sasser, Jr. in a Harvard Business Review article, "companies can boost their profits by almost 100% by retaining just 5% more of their customers." The early stage of CRM was focused on the call center, where customer interaction took place through telemarketing, telesales and follow-up customer service. Although call centers were a first step in the CRM initiative, they were limited to only the telephone. In addition, call centers were often not integrated with back office transaction processing systems. As a result, significant amounts of manual processing were necessary to fulfill a customer's request. With advances in the Internet and information technology, CRM has become more sophisticated and complex. As a result of the Internet, customer expectations have increased, barriers to market entry have decreased and competitors are only a click away. The Internet also enables companies to obtain additional customer information and feedback at considerably reduced costs. To meet new customer expectations, ward off competitors and make use of new customer information, companies need to link their existing CRM solution into this new electronic environment. We define the market opportunity created by this business need as eCRM. eCRM is therefore an expansion of CRM to further include the Internet, e-mail and web-chat across each division of a company. Currently, no single software product can provide all of the capabilities needed to effectively address the eCRM market. To see why this is true, we need to examine the components of the eCRM market. The eCRM market can be separated into six significant components: Channel Management, eCommerce, Customer Segmentation, CRM Applications, Back Office and Call Center Technology. 4 7 Companies today require these software products to be integrated into an enterprise-wide solution that incorporates all the various ways that companies communicate with their customers including the Internet, e-mail, web-chat, telephone and fax, and provides a seamless integration of these channels to support core business operations. Increasingly, companies are looking for outside providers to implement these initiatives directed at improving customer loyalty. The Gartner Group, an information technology research firm, predicts that the market for CRM services will grow from $2.9 billion in 1998 to $20.8 billion in 2003. The following diagram illustrates those six components grouped by their functionality, as well as examples of third party vendors who provide software in each category. Significant Components of the eCRM Market [CHANNEL MANAGEMENT] [CUSTOMER SEGMENTATION] [CRM APPLICATIONS] [eCOMMERCE] [CRITICAL VOID] [BACK OFFICE] [CALL CENTER TECHNOLOGY] [eLOYALTY APPROACH] While a well-defined technical system design is needed to successfully integrate these software products, the value of an eCRM solution is derived from combining this technical system design with an effective business strategy. The business strategy defines the policies for managing customer relationships and involves grouping customers into value segments and analyzing potential customer interactions. Business rules need to be created to define the specific actions that should be taken each time a customer interaction occurs. The results of these actions then need to be analyzed to ensure that the customers' loyalty has increased due to the interaction. A loyalty solution is an eCRM business and technology solution that is designed to help companies build lasting relationships with their customers, maximize the efficiency of customer interactions and capitalize on selling opportunities based on customer information gathered during these interactions. 5 8 THE eLOYALTY DIFFERENCE We believe we are a leading provider of loyalty solutions for the following reasons: - ACTION-ORIENTED APPROACH TO CREATING LOYALTY We help our clients by identifying appropriate customer loyalty goals, improving customer retention, increasing up-selling and cross-selling opportunities, reducing sales costs and increasing customer referrals. We identify these goals by analyzing and segmenting a client's customer base using key indicators including value, preference and potential sales opportunities. We work with the senior executives of our clients to help organize the company's approach to its customers based on the results of our analysis. Our approach is designed to translate the customer loyalty goals of our clients into operational business rules. The business rules prescribe a set of specific actions to be used by our client to help increase customer loyalty. In essence, we work with our clients to help them create practical steps to optimize everyday customer interactions. - ABILITY TO DESIGN AND INTEGRATE MULTI-CHANNEL ENTERPRISE-WIDE SOLUTIONS We provide our clients with the necessary skills to develop enterprise-wide loyalty solutions. We understand the technology, software applications and components across the Internet, e-mail, web-chat, telephone and fax. We are able to design solutions that integrate various point applications, our proprietary software and the back office transaction processing systems of our clients. Our familiarity with emerging technology and software applications used in the eCRM market coupled with our understanding of key business processes allow us to implement successful loyalty solutions. - PROPRIETARY TECHNOLOGY THAT ENHANCES OUR SOLUTIONS We have developed software that is designed to complement existing technology and point applications. The availability of this software reduces the time needed to deploy our solutions. In addition, our software increases the functionality of third-party applications that are used in our solutions. Our proprietary software, the Loyalty Suite(TM), enables us to design a comprehensive solution that takes advantage of emerging technology. We develop software in our Loyalty Lab, which is a showcase for our business and technology capabilities. The Loyalty Lab is also used as a demonstration center for current and prospective clients and as a training center for employees. In addition, we use the Loyalty Lab to create prototypes and test solutions before they are implemented at a client's site. - ONGOING SUPPORT FOR OUR SOLUTIONS Loyalty solutions are complex multi-channel implementations that include many different software applications in an integrated design. To maintain optimal operating performance, a wide breadth of knowledge is required to understand each individual component and also how the pieces of the solution fit together. Each time one of these application vendors releases a new version of their software, our clients need to understand and verify the compatibility with the other components of their solution. These upgrades normally take place at least twice a year for each application and our clients are often unable to attract or retain resources with the broad range of skills in each of the existing and emerging technologies. Our Loyalty Support group provides around-the-clock support of the entire loyalty solution to ensure that all of our clients' customer-facing systems are operational. We also offer a broad range of maintenance, upgrade and performance monitoring services to establish a benchmark for our client's operations and to identify opportunities for continual improvement. In 1999, we received the Solution Integrator of the Year Award for New Business for our support offering. - EXPERIENCED PROJECT TEAMS Our differentiated delivery model uses a team of between ten and fifteen principals and senior consultants, providing a solid core of experience. This group is led by two to three Vice Presidents and complemented by a similar number of supporting consultants. We believe this model provides us with 6 9 an advantage over some of our competitors, who prefer a pyramid model of pairing one partner with many less experienced professionals. Many of our consultants have held senior management positions including Chief Executive Officer, Chief Financial Officer and Chief Information Officer. Our 100 Vice Presidents average 20 years of relevant industry experience and are distinguished in their ability to manage and deploy complex and multi-channel solutions. The average years of experience for our other professionals is 12 years. This level of experience has helped us to realize an average billing rate of $219 per hour for the three months ended December 31, 1999. - ABILITY TO SERVE CLIENTS ON AN INTERNATIONAL BASIS We are an international company with a large presence in North America and we also have offices in London, Cologne, Paris, Sydney and Toronto. We have an established presence in Europe and are now expanding in Asia Pacific. For the year ended December 31, 1999, 22.3% of our revenues were derived from our international operations. Through our Loyalty Lab and knowledge base of shared projects, methodologies and best practices, we have demonstrated to our multi-national clients our ability to provide loyalty solutions tailored to their local needs and requirements. STRATEGY Our objective is to be the leading international provider of loyalty solutions. We intend to substantially increase our revenues and profitability and to create an international brand name. Our strategy to achieve these goals includes the following: - FOCUS ON THE BUSINESS BENEFITS WE DELIVER TO OUR CLIENTS We focus on highly strategic projects that are designed to improve the profitability of our clients. We identify customer loyalty goals and design business rules that prescribe a specific set of actions used by the client to increase customer loyalty. We perform detailed financial analysis to calculate the expected return on investment from implementing our loyalty solutions. Based upon our experience to date, we believe that the expected business benefits derived from using our loyalty solutions will measurably improve our clients' profitability. We may from time to time offer clients a value-based pricing model for our solutions based upon these expected business benefits. We believe that this pricing model (which we call Guaranteed Business Benefits) will be of significant interest to our clients and differentiate us from our competitors. Under this model, we may reduce our billing rates or limit our fees in exchange for a share of the expected economic benefits to our clients from implementing our solutions. By sharing in the cost savings, profitability and increased revenues that result from our solutions, we anticipate that we will experience greater client satisfaction, higher revenues and increased profitability. - EXTEND OUR TECHNOLOGY INNOVATION AND THOUGHT LEADERSHIP We will continue to invest the necessary resources to develop leading-edge loyalty solutions. The investment is directed in two main areas: emerging eCRM technology and business thought leadership that we define as leading-edge research on customer behavior. To be at the forefront of emerging technology, specifically the Internet, we will continue to maintain and develop relationships with leading software vendors. We have strategically invested in a talented group of technology experts that focus exclusively on creating innovative loyalty solutions. Our Loyalty Lab is the focal point for these activities in addition to providing a demonstration center for our competencies. We plan to advance our business thought leadership and education on the concepts of customer loyalty. We intend to explore areas including brand impact, customer perception and satisfaction, the 7 10 interdependency of multiple interactions to ensure that our loyalty solutions reflect and extend the most forward-thinking business ideas. We believe that our technology and business capabilities will significantly enhance our competitive position by enabling us to deliver more complete solutions. - CONTINUE TO ENHANCE OUR LOYALTY SOLUTIONS We currently have two separate initiatives to enhance our loyalty solutions: extend our current Loyalty Support services and introduce our Loyalty Foundation (or hosting) offering. We have been providing our clients with our Loyalty Support service to ensure that our implementations result in continued business value to our clients. We provide around-the-clock maintenance, support and upgrade services. We intend to additionally provide business performance monitoring to identify opportunities for continual improvement of their loyalty solutions. We intend to offer additional flexibility to our clients with our Loyalty Foundation offering. This offering will provide remote subscription to our loyalty solutions for those clients who desire to reduce risk, time and initial investment in their effort to use a sophisticated design to realize the on-going value of our loyalty solutions. - BUILD STRATEGIC VENDOR RELATIONSHIPS We will continue our investment in two kinds of strategic vendor relationships. First, we plan to collaborate with the leading-edge technology and application vendors to gain access to new products at an early stage of release. This early access allows us to rapidly develop the necessary implementation and integration skills required in our loyalty solutions. Second, we intend to establish vendor relationships as part of our overall sales efforts including joint lead development and sales calls. The purpose of these relationships is to give us alternate channels for developing new business. We have been collaborating with Cisco Systems, Siebel Systems, and Nortel-Clarify and are in the process of establishing more formal arrangements with them. - CONTINUE TO BUILD BRAND AWARENESS A successful brand results in a greater ability to attract new clients and employees as well as to improve competitive positioning. We will continue to invest in marketing programs to build brand awareness through regular publications, award sponsorship, communications with analysts, trade shows, industry events and marketing material. In 1999, eLoyalty received Solutions Integrator magazine's SI Impact Award for Solution Integrator of the Year. In addition, our Loyalty Support services received the SI Impact Award for New Business. We are the founder and a sponsor of the prestigious Computerworld Smithsonian 21st Century Pioneer Awards Program and the sponsor of Britain's Most Admired Company award. - CONTINUE TO INVEST IN INFRASTRUCTURE We plan to continue our strategic investments in operational and management information systems. We have developed a sophisticated web-based management information system, GetLoyal.com, that provides us with a real-time global view of our staffing, pipeline, scheduling, forecasting, accounting and client information. We will continue to refine and upgrade our management systems so that we can optimize our resource allocation and achieve our target operational measures. - CONTINUE TO ATTRACT AND RETAIN EMPLOYEES Our key assets are our employees. We will continue to invest in the necessary resources to attract and retain highly qualified and motivated personnel. We have concentrated on fostering an energetic working environment that facilitates and rewards initiative and achievement. In keeping with this goal, we are developing our Employee Loyalty program, an enterprise-wide human resources management program. The Employee Loyalty program is designed to create a culture that engenders communication, recognize significant employee achievements and provide training on new technology. In addition, we intend to make available to all of our employees stock options and other performance-based incentives. 8 11 In our five years of operation, the success of our human resources management is reflected in the average tenure of our employees. As of December 31, 1999 the average tenure of our senior management was 49.8 months, Vice Presidents 40.0 months and other professionals about 23.7 months. - EXPAND OUR INTERNATIONAL PRESENCE We expect our plans for international expansion will allow us to capitalize on high-growth geographic regions and further diversify our revenue base. We also believe this will enable us to develop closer relationships with our multi-national clients who are increasingly seeking service providers with experience in addressing their needs and requirements on an international basis. We are committed to ensuring the consistency and quality of our loyalty solutions worldwide through our Loyalty Lab and knowledge base of shared projects, methodologies and best practices. THE eLOYALTY SOLUTION We believe that our ability to deliver successful loyalty solutions to our clients results from our approach, our competencies and the software that we develop in-house. Our approach is a methodology that we adopt to define, identify and articulate the various elements that create a successful loyalty solution. Our competencies allow us to address the business needs of our client. These competencies include strategic consulting skills, business value analysis, business process redesign, technical system design and integration of various technologies and software applications and post-implementation support. Our software enables us to complement the functional gaps of existing technology and eCRM applications and helps reduce time to implementation, reduce deployment risks and increase the functionality of our loyalty solutions. Approach eLoyalty has developed a four-step methodology to translate high-level strategy into an implementation design: - DEFINE: Identify the specific situation of a customer at any point in time; - RECOGNIZE: Create rules that prescribe the actions to be taken by the client when these specific circumstances have been identified; - EXECUTE: Enable the client to execute these actions across any of the various ways that companies communicate with their customers each time a contact with the customer occurs; and - MEASURE: Report and diagnose the effectiveness of these actions on customer loyalty. By executing this approach, organizations can influence behavior resulting in greater customer loyalty. Competencies Successful loyalty solutions generally require a combined knowledge of business strategy and technology application. To provide our clients with a complete solution, we have developed capabilities in many key business consulting disciplines, technology integration and system design. Our competencies include repeatable methodologies and proprietary tools that should increase the success and effectiveness of our projects. The following list highlights our core competencies: - ASSESSMENT -- Working with our clients, we evaluate their efficiency and effectiveness in handling customer interactions. We use our Loyalty Observer(TM), a proprietary software tool, to help with this process. The Loyalty Observer enables our professionals to capture and analyze the performance measures of each customer interaction, including the number of legacy systems used to handle the situation, interaction time, reason for interaction and actions taken to resolve any customer issues. We use these results to influence the Business Process Design. - STRATEGIC CONSULTING -- Through our strategic consulting competency, which we call Loyalty Strategy, we assist our clients in identifying their most valuable customers through detailed segmentation of their 9 12 customer base. We use this segmentation to target high-value customers to receive special offers or service levels designed to increase their loyalty to our client. Enhanced loyalty results in increased purchases, reduced cost of sales and additional customer referrals. - BUSINESS CASE -- Based on the results of our strategic consulting and operational assessment, we perform a detailed financial analysis to calculate the expected return on investment for the implementation of our loyalty solutions. Our Business Case also establishes goals, alternatives and priorities and assigns client accountability throughout resulting projects. - BUSINESS PROCESS DESIGN -- Following our Business Case analysis, we select the appropriate loyalty solution for our client. The implementation of our loyalty solutions can lead to significant organizational, structural, operational and staffing changes. Our Loyalty Process Design is the method we employ to determine the changes in business processes and organizational structure required to implement our loyalty solutions. Our clients implement these changes because of the tangible business benefits identified by our Business Case analysis. - TECHNICAL DESIGN AND SYSTEMS INTEGRATION -- This competency allows us to implement the technical aspects of our loyalty solutions. We design a loyalty solution to integrate a variety of software applications from third-party vendors and our own Loyalty Suite. The applications we integrate include channel management, customer segmentation, CRM applications, eCommerce, back office and call center technology. - SUPPORT AND HOSTING -- Through our Loyalty Support capabilities, we provide ongoing maintenance, technical upgrades, benchmarking and we monitor our solutions to ensure high quality service and efficiency. We intend to offer hosting services of our loyalty solutions on behalf of our clients. Loyalty Foundation will provide our clients with remote access to our loyalty solutions. By using this solution, our clients will experience less risk, time and initial investment in their effort to enhance customer loyalty. Software The Loyalty Suite is a set of software applications that we license to our clients. Our software ties together the critical components of the loyalty solution. The Loyalty Suite provides sophisticated real-time information, allowing the client to handle each customer interaction in a consistent manner throughout the enterprise. As of December 31, 1999, we had implemented components of our Loyalty Suite to over 30 of our clients as part of our solution. The Loyalty Suite currently consists of the following: - LOYALTY COCKPIT(TM) -- The Loyalty Cockpit is a desktop portal providing real-time customer information collected throughout the enterprise. The application is designed for employees that interact with customers. The user benefits from an enterprise view of the customer. A sophisticated scripting feature assists the user to navigate quickly to the multiple point solutions required to effectively manage the interaction. This is accomplished by automating the sequence and the access to various CRM applications and back office systems. - LOYALTY REPOSITORY(TM) -- The customer information contained in the Loyalty Repository enhances and extends existing data stored in CRM applications, legacy systems and marketing databases. The information is used to determine customer loyalty indicators such as customer value, preference and potential sales opportunities. Unlike traditional application databases, the Loyalty Repository is specifically designed for optimum use in real-time for quickly accessing multiple pieces of customer information. The data model is highly flexible allowing companies to define specific parameters for their loyalty indicators in real-time. For example, the levels at which customer value is segmented are assigned using the Loyalty Rules Configurator, and can be changed dynamically to reflect a company's loyalty goals. - LOYALTY RULES CONFIGURATOR(TM) -- The Loyalty Rules Configurator is the user interface for the Loyalty Decision Engine. It is designed for the business user, allowing non-technical managers to define key characteristics of their customers, employees, events and actions. Business managers can then decide 10 13 which resources and actions to select for specific customer profiles and in specific situations. These decisions are stored as "rules" by the application and reflect the multi-dimensional aspects of the customer relationship strategy. - LOYALTY DECISION ENGINE(TM) -- The Loyalty Decision Engine is the brain of the Loyalty Suite. It is a powerful, efficient, server-based application that applies loyalty business rules across multiple channels and enterprise applications. - LOYALTY OUTCOME MANAGER(TM) -- The Loyalty Outcome Manager is a web-based application that enables companies to streamline their data collection and measurement processes. It enables companies to test and report on their performance through measurement and analysis of key customer, event and resource information that is collected over time. The Loyalty Outcome Manager reduces the time and cost to provide companies with a customer loyalty scorecard. - LOYALTY CHANNEL INFLUENCER(TM) -- The Loyalty Channel Influencer pulls information from customer interactions across the Internet, e-mail, web-chat, fax and interactive voice response systems. This information is then stored in the Loyalty Repository for use with future customer interactions. - LOYALTY WAREHOUSE(TM) -- The Loyalty Warehouse is a database that stores information about customers, human resources, events, actions and customer interactions. It is a chronological history of information that reflects patterns and trends of customer loyalty data over time. The Loyalty Warehouse is a flexible model that is able to continually respond to the dynamic nature of a company's customer relationship and loyalty information. This data model is specifically designed for optimum processing of large data requests such as batch reporting. CLIENTS During 1999, eLoyalty's five and twenty largest clients accounted for 22.2% and 54.8% respectively, of our revenues. No single client accounted for more than 10% of our total revenues in any quarter during that period. For the year ended December 31, 1999, 45 clients each accounted for over $1 million of revenues. Revenues for professional services and support services represent approximately 99% of our total revenues. We typically experience seasonal fluctuations in our revenues and earnings on a global basis in the fourth quarter because of the reduced number of billing days due to holidays. In addition, we have experienced a slight decrease in revenues from our European operations in the third quarter because of extended vacation periods. Although those decreases in revenues have not been significant in the past, they may increase as we expand internationally. The following is a representative list of companies for which we provided solutions for the year ended December 31, 1999: - ADAC Laboratories, Inc. - A&E Signature Services, a Division of Montgomery Wards - Agilent Technologies, Inc. - Allina Health System - Allstate Insurance Company - Axel Springer Verlag AG - Bank of America Corporation - British Broadcasting Corporation (BBC) - Club Mediterranee (Club Med) - Deutsche Telekom AG - Federal Kemper Life Assurance Company - General Motors Corporation - Intuit Inc. - Lucent Technologies, Inc. - News Limited - Penn Treaty American Corporation - Sprint Communications Company, L.P. - Union Bank of California, N.A. - USA Group, Inc. - U S WEST Communications, Inc. - Virgin Atlantic Airways Limited - Xerox Canada Ltd. CASE STUDIES The following are examples of actual client services we have provided. In each case the client has given us permission to describe the solution that we provided for them. These case studies therefore illustrate some of the solutions that we have created for our clients. 11 14 PENN TREATY AMERICAN CORPORATION CHALLENGE To help our client improve its competitive position and to make their sales agents more effective in building long-term relationships with their customers by providing alternative channels to improve the sales and accuracy of processing sales orders and increase their on-line marketing capabilities. SOLUTION - Developed an on-line system for our client's national independent agency network for access to real-time information on insurance quotes and status of pending customer policies and applications. - Created a solution that simplified and streamlined the sales process. This new solution enabled agents to complete their customer policy applications in real-time, thereby creating a competitive advantage. - Defined and implemented an overall technical design to support these new systems and their customer relationship strategy. - Currently creating individual web sites for all the agents that will allow them to have a direct relationship with their customers and engage in eCommerce. We intend to link these web sites to the on-line system, enabling agents to obtain real-time insurance quotes and status on pending customer policies and applications directly from their individual web sites. This will significantly improve the marketing capability of these agents. FEDERAL KEMPER LIFE ASSURANCE COMPANY CHALLENGE Help our client achieve the following objectives: (1) streamline the management of their customer interactions; (2) develop a consistent mechanism for handling their customers; and (3) support the roll-out of new channels for their customer interactions. SOLUTION - Developed a methodology and set of business rules that supported target marketing and proactive selling to their customers based upon the knowledge of each customer and distribution channel. A pilot campaign increased outbound sales call productivity between 30% and 50%. - Deployed the overall solution including software developed in our Loyalty Lab that enabled a multi-channel management of customer interactions. - Automated numerous manual functions and integrated the solution with back office processing systems resulting in a more efficient sales and fulfillment process. - Provided support services to maintain and support the customized technology environment. - By implementing a consistent technical design throughout our client's enterprise, we were able to help our client share valuable information about their customers across multiple divisions. This improved our client's ability to up-sell and cross-sell their products and services to their customers. - Our solution is credited with helping our client to realize multi-million dollar cost savings and increased sales as well as a significant reduction in employee attrition partially due to the introduction of easy-to-use customer service desktops powered by the Loyalty Cockpit. 12 15 AXEL SPRINGER VERLAG AG CHALLENGE Help our client achieve the following objectives: (1) reduce operational costs; (2) increase sales; and (3) strengthen their competitive position. SOLUTION - Developed an effective strategy to facilitate and improve our client's customer relationships by deploying multimedia customer interaction centers that handled e-mail, fax, telephone calls and written correspondence. By defining the overall strategy and technical design that integrated a number of customer contact channels, our client could more cost-effectively influence their customer's experience and focus on additional selling opportunities. - Created a set of best practices for each of the various ways that companies communicate with their customers to ensure high quality service and consistent management of their customers. - Integrated the solution with the third-party order processing software from SAP AG and legacy systems resulting in a seamless and consistent technical design throughout our client's company. This provided the ability for our client to handle multiple customer requests across different divisions. - Developed a web-based transaction processing application that captured real-time information about customer inquiries. Our client used this information to increase up-selling and cross-selling opportunities for its products across all customer channels. - Implemented our software to allow our client to collect detailed information about their customer's needs and preferences. This information was used to tailor their products and services to increase sales and to increase up-selling and cross-selling opportunities. - Centralized customer contacts relating to more than 20 different product lines into two multimedia centers offering around-the-clock access for their customers. SALES AND MARKETING Our sales and marketing efforts are performed by our senior level professionals, the majority of whom are also responsible for managing the implementation of our solutions. We have recently created two new sales and marketing groups, the business development team and the solutions marketing group. Our business development team consists of experienced industry professionals who focus on new client opportunities. Our solutions marketing group establishes relationships with select vendors and leverages their distribution networks to accelerate the acquisition of new clients. Our goal is to maintain long-term relationships with our clients in order to generate recurring revenues. BUSINESS DEVELOPMENT TEAM -- Our business development team targets Global 2000 companies. This team is a set of senior professionals with an average industry experience of 12 years. These professionals develop executive level relationships with our clients. As of December 31, 1999, eLoyalty had 20 business developers, each dedicated to a specific region. SOLUTIONS MARKETING -- We are in the process of establishing more formal arrangements with companies such as Lucent Technologies and DST Systems. We expect that these relationships will provide us with alternative channels for identifying prospective clients. We intend to develop more of these relationships to increase our market share. In addition, our solutions marketing group seeks to communicate a consistent message to our professionals on the availability, use, pricing and integration of our solutions and leverage the benefits of our Loyalty Lab. This communication results in the reduction of technical risk, time and cost associated with the delivery of our solutions. 13 16 AGGRESSIVE BRAND DEVELOPMENT -- Following the launch of the eLoyalty brand, we continue to expand our strategic initiatives to create greater awareness of our solutions. We have conducted aggressive marketing and branding programs that include the development and launch of our new web site, frequent press releases and new marketing material. Our Journal of Customer Loyalty, a quarterly publication featuring articles by industry professionals, has a distribution list of over 19,000 and is supplemented by a monthly e-mail campaign entitled "All Roads Lead to Loyalty." We also have direct mail campaigns, joint marketing, industry and investment analyst relations and trade show participation and sponsorship. We are also a sponsor of two awards that recognize individuals and companies on their quality of operations. We established the Computerworld Smithsonian 21st Century Pioneer Awards Program to honor prestigious companies and individuals that leverage technology to benefit society. Management Today's "Britain's Most Admired Companies" researches companies from several sectors to find the one that has the best reputation among its competitors based on categories such as quality of marketing, use of corporate assets, quality of products/services and many others. These award programs give eLoyalty the opportunity to promote its name recognition globally and continue its positioning as an industry thought leader. RESEARCH AND DEVELOPMENT The market we operate in is constantly evolving due to changing business needs and the increasing number of software products that are available. We believe that it is necessary to invest in research and development to remain competitive. In 1998, we formally established our Loyalty Lab as a center for our research and development group. The lab is an important part of our strategy and we have made significant investments to build our research and development over the last four years and we plan to continue these investments. As of December 31, 1999, 40 employees were working in our Loyalty Lab. Our software, called the Loyalty Suite, provides our clients with functionality that is not currently available from third party software vendors as part of their standard product offering without additional development. Our software helps to tie the components of the loyalty solution together and capture important customer loyalty information. The Loyalty Suite has been designed using the experience we have gained from developing loyalty solutions for our clients over the past five years. The objectives of our Loyalty Lab are as follows: - to enhance the Loyalty Architecture through research and evaluation of emerging technologies; - to work closely with technology partners to decrease the time and difficulty of integration; - to develop and enhance the Loyalty Suite; - to be a center for demonstrating loyalty solutions to our current and prospective clients; and - to train our employees on our solutions. eLoyalty's research and development expenditures for fiscal 1997 and 1998 were approximately $1.7 million and $2.4 million, respectively. We spent $5.1 million and $3.6 million on research and development for years ended December 31, 1999 and December 31, 1998 respectively. TECHNOLOGY EXPERIENCE -- We have collaborated with vendors to allow us to more effectively integrate their software into our solutions. This experience enhances our ability to provide a more complete solution. The relationships that we have with these vendors are non-exclusive. The following list is an example of some of these vendors: - BroadVision, Inc. - Cisco Systems, Inc. - Clarify, Inc. - DST Systems, Inc. - eFusion, Inc. - E.piphany Incorporated - Genesys Corporation - Kana Communications, Inc. - Lucent Technologies, Inc. - Nuance Communications, Inc. - Oracle Corporation - RightPoint Software, Inc. 14 17 - SAP AG - Servicesoft Technologies, Inc. - Silknet Corporation - Speechworks International, Inc. - Siebel Systems, Inc. - TriVida Corporation - Vantive Corporation - Vignette Corporation - Webline Communications Corporation COMPETITION Although the CRM market has been in existence for some time, the eCRM market in which we compete is relatively new and very competitive. We expect competition to intensify even further as this market evolves. Many of our competitors have longer operating histories, more clients, longer relationships with their clients, greater brand or name recognition and significantly greater financial, technical, marketing and public relations resources than we do. As a result, our competitors may be in a better position to respond quickly to new or emerging technologies and changes in client requirements. They may also develop and promote their products and services more effectively than we do. These risks are especially pronounced in our industry where we will face major challenges from other companies including: - systems integrators such as Andersen Consulting, Deloitte & Touche LLP, Ernst & Young LLP, KPMG LLP, PricewaterhouseCoopers LLP, Arthur Andersen LLP, IBM Global Services, Cambridge Technology Partners, Sapient Corporation, and Diamond Technology Partners; - Internet and eCommerce services companies such as Scient Corporation, Viant Corporation, Proxicom, Inc., AppNet Inc., Tanning Technology Corporation and Razorfish, Inc.; - large information technology services companies such as Computer Sciences Corporation and Perot Systems Corporation; - management consulting firms such as Bain & Company, Booz, Allen & Hamilton, Boston Consulting Group, Inc. and McKinsey & Company; and - internal information technology departments of current and potential clients. New market entrants pose a threat to our business. Existing or future competitors may develop or offer solutions that are comparable or superior to ours at a lower price. In addition, several competitors have announced their intention to offer a broader range of services than they currently provide. Many of our competitors focus on the implementation of CRM applications. We believe that we are differentiated from our competition by our ability to provide a complete loyalty solution. We believe that this involves a combination of several different and specialized skills including: - strategic business consulting to define a company's policies for managing customers in each division and group within the organization; - technical knowledge in each of the different products that a company needs to communicate with their customers using the Internet, telephone, e-mail and fax; - integration techniques to enable each of these software products to be tied together; and - ongoing support or hosting of their loyalty solution to meet changing business requirements and emerging technology. INTELLECTUAL PROPERTY RIGHTS A majority of our clients require that we grant to them all proprietary and intellectual property rights with respect to the work product resulting from our performance of solutions, including the intellectual property rights to any custom software developed by us for them. Each grant of proprietary and intellectual property rights limits our ability to reuse work product components and work product solutions with other clients. In a limited number of such situations, we have obtained, and in the future may attempt to obtain, an ownership interest or a license from our clients to permit us to market custom software to other clients. These 15 18 arrangements may be nonexclusive or exclusive, and licensors to us may retain the right to sell products and services that compete with those of eLoyalty. We also develop core software and methodologies, such as the Loyalty Suite, that are owned by us and licensed to our clients. We regard these software and methodologies as proprietary and intend to protect our rights, where appropriate, with registered copyrights, patents, registered trademarks, trade secret laws and contractual restrictions on disclosure and transferring title. In addition, to protect our proprietary information, we rely upon a combination of trade secret and common law, employee nondisclosure policies and third-party confidentiality agreements. EMPLOYEES As of December 31, 1999, eLoyalty employed 715 persons of which 556 were billable employees. Of the 715 employees, 589 were located in North America, 107 in Europe and 19 in Australia. Our business is mainly of professional services and is inherently people intensive. We believe we have a satisfactory relationship with our employees. Our average annualized turnover of billable employees was 17.1%. None of our employees is represented by a union. Most of our European employees have employment agreements generally requiring three months' notice of termination by us. In addition, the laws and regulations of the foreign countries in which we operate may increase the cost of terminating employees in those countries. We maintain various programs and strategies to retain and recruit employees. ITEM 2. PROPERTIES Our principal executive office is located at 205 North Michigan Avenue, Suite 1500, Chicago, Illinois and consists of approximately 15,000 square feet of leased office space. We expect that in April 2000 we will move our headquarters to Two Conway Park, 150 Field Drive, Lake Forest, Illinois 60045. Our offices there will consist of approximately 20,816 square feet. We also lease office space throughout the United States and abroad, in some cases pursuant to subleases with Technology Solutions Company. Our domestic offices are located in Austin, Texas, San Francisco, California and Waltham, Massachusetts. In March 2000 we signed a new lease in Austin, Texas for approximately 41,000 square feet. Our international offices are located in London, Cologne, Paris, Sydney and Toronto. Pursuant to the reorganization agreement between us and Technology Solutions Company, we will also have the ability to use, subject to some restrictions, Technology Solutions Company offices in Atlanta, Georgia, Dallas, Texas, Los Angeles, California, Minneapolis, Minnesota and New York City through June 30, 2000 for no charge. Technology Solutions Company also has comparable rights to use our domestic branch offices for the same period and subject to the same terms, conditions and restrictions. ITEM 3. LEGAL PROCEEDINGS The Company is involved in various pending or threatened claims arising out of the normal course of business. Management believes that losses, if any, arising from such claims will not have a material adverse effect on the Company's financial position, results of operations or cash flows. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the fourth quarter ended December 31, 1999. 16 19 PART II ITEM 5. MARKET FOR REGISTRANTS' COMMON EQUITY AND RELATED STOCKHOLDER MATTERS In connection with establishing eLoyalty as a separate legal entity, 100,000,000 shares of common stock, $.01 par value, were authorized, of which a total of 41,400,000 shares of common stock were issued to TSC. The Company also has authorized 10,000,000 shares of preferred stock, $.01 par value, of which none have been issued. The Company's common stock began trading on February 16, 2000 on the NASDAQ exchange under the symbol ELOY. On March 24, 2000 the common stock was held by 733 stockholders of record. On March 24, 2000 the reported last sales price for a share of common stock was $30.8125. Since the spin off, the Company has not declared any cash dividends or distributions on its common stock. The Company currently intends to retain its earnings to finance future growth and therefore has no present intention of paying dividends. Any payment of dividends in the future is dependent upon the financial condition, capital requirements, earnings of the Company and other factors. The Company's dividend policy will be reviewed quarterly by the Company's Board of Directors. ITEM 6. SELECTED FINANCIAL DATA The following tables summarize selected financial data of eLoyalty. This information should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations," and the historical financial statements and notes thereto which are included elsewhere in this Annual Report on Form 10-K. The statement of operations data for the year ended December 31, 1999, for the seven month period ended December 31, 1998 and for each of the three years ended May 31, 1998, 1997, 1996 and the balance sheet data as of December 31, 1999 and 1998 and May 31, 1998 and 1997 below are derived from the audited combined financial statements. The statement of operations data for the year ended December 31, 1998, for the seven month period ended December 31, 1997, and for the year ended May 31, 1995, and the balance sheet data as of May 31, 1996 and 1995 are derived from unaudited combined financial statements. In the opinion of management, the unaudited combined financial statements discussed above, reflect all adjustments, consisting of normal adjustments, necessary to present fairly eLoyalty's results of operations for the year ended December 31, 1998, the seven month period ended December 31, 1997 and for the year ended May 31, 1995, and its financial position as of December 31, 1996 and 1995. The historical financial information may not be indicative of eLoyalty future performance and does not necessarily reflect what the financial position and results of operations of eLoyalty would have been had eLoyalty operated as a separate, stand-alone entity during the periods presented. 17 20 eLOYALTY STATEMENT OF OPERATIONS DATA (IN THOUSANDS, EXCEPT PER SHARE DATA)
FOR THE FOR THE YEARS SEVEN MONTH PERIODS ENDED FROM JUNE 1 TO DECEMBER 31, DECEMBER 31, FOR THE YEARS ENDED MAY 31, ---------------------- ---------------------- -------------------------------------------- 1999 1998 1998 1997 1998 1997 1996 1995 -------- ----------- -------- ----------- -------- -------- -------- ----------- (UNAUDITED) (UNAUDITED) (UNAUDITED) REVENUES......................... $146,003 $105,235 $ 64,415 $ 43,668 $ 84,488 $ 43,181 $ 26,516 $ 6,132 Project personnel............... (72,412) (50,687) (31,302) (22,329) (41,329) (18,078) (11,674) (3,137) -------- -------- -------- -------- -------- -------- -------- ------- GROSS PROFIT..................... 73,591 54,548 33,113 21,339 43,159 25,103 14,842 2,995 -------- -------- -------- -------- -------- -------- -------- ------- OTHER COSTS AND EXPENSES: Sales and marketing............. 9,703 4,894 3,456 994 2,429 1,663 1,032 312 Research and development........ 5,093 3,635 2,889 1,393 2,383 1,689 46 -- General and administrative...... 31,916 26,326 16,438 10,641 20,216 11,539 5,559 1,335 Technology Solutions Company corporate services allocation.................... 13,378 12,769 7,698 5,544 10,671 5,028 3,298 1,527 Goodwill amortization........... 4,996 3,794 2,450 1,856 3,201 376 -- -- Equity in net loss of unconsolidated investee....... 463 412 412 -- -- -- -- -- -------- -------- -------- -------- -------- -------- -------- ------- 65,549 51,830 33,343 20,428 38,900 20,295 9,935 3,174 -------- -------- -------- -------- -------- -------- -------- ------- OPERATING INCOME (LOSS).......... 8,042 2,718 (230) 911 4,259 4,808 4,907 (179) -------- -------- -------- -------- -------- -------- -------- ------- OTHER INCOME (EXPENSE): Net investment income........... 127 95 116 39 68 15 -- -- Interest expense................ (72) (74) (31) (53) (92) -- -- -- -------- -------- -------- -------- -------- -------- -------- ------- 55 21 85 (14) (24) 15 -- -- -------- -------- -------- -------- -------- -------- -------- ------- INCOME (LOSS) BEFORE INCOME TAXES........................... 8,097 2,739 (145) 897 4,235 4,823 4,907 (179) INCOME TAX PROVISION (BENEFIT)... 4,039 1,672 398 562 2,022 1,897 1,857 (51) -------- -------- -------- -------- -------- -------- -------- ------- NET INCOME (LOSS)................ $ 4,058 $ 1,067 $ (543) $ 335 $ 2,213 $ 2,926 $ 3,050 $ (128) ======== ======== ======== ======== ======== ======== ======== ======= Basic net income (loss) per common share(1)................. $ 0.10 $ 0.03 $ (0.01) $ 0.01 $ 0.05 $ 0.07 $ 0.07 $ (0.00) Diluted net income (loss) per common share(1)................. $ 0.09 $ 0.02 $ (0.01) $ 0.01 $ 0.05 $ 0.06 $ 0.07 $ (0.00) Shares used to calculate basic net income (loss) per share (in millions)(1).................... 41.4 41.4 41.4 41.4 41.4 41.4 41.4 41.4 Shares used to calculate diluted net income (loss) per share (in millions)(1).................... 44.2 43.1 41.4 45.8 46.8 46.6 45.5 41.4
- --------------- (1) In December 1999, eLoyalty issued 41.4 million shares to Technology Solutions Company. Basic earnings per share have been computed by dividing the net income/(loss) for each period presented by the 41.4 million shares. Diluted net earnings per share was computed by dividing the net income/(loss) for each period presented by the 41.4 million shares plus the estimated effect of dilutive stock options using the "treasury stock" method. See Note 8 to the Notes to the Combined Financial Statements for a discussion of stock options. eLOYALTY BALANCE SHEET DATA (IN THOUSANDS)
AS OF DECEMBER 31, AS OF MAY 31, -------------------------- --------------------------------------------- 1999 1998 1998 1997 1996 1995 ----------- ------------ ------- ------- ----------- ----------- (UNAUDITED) (UNAUDITED) Cash........................... $13,462 $ 4,411 $ 4,726 $ 4,130 $ 321 $ -- Working capital................ $54,927 $26,231 $23,840 $13,506 $ 6,249 $3,130 Total assets................... $96,603 $63,904 $54,118 $24,188 $14,008 $4,351 Stockholder's equity........... $73,615 $47,888 $40,893 $17,147 $ 9,312 $3,169
18 21 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with eLoyalty's Financial Statements and Notes and the other financial information appearing in this Form 10-K. In addition to historical information, the following discussion and other parts of this Form 10-K contain forward-looking information that involves risks and uncertainties. eLoyalty's actual results could differ materially from those anticipated by such forward-looking information for many reasons, including competitive factors, risks associated with eLoyalty's expansion plans, and transitional service agreements with Technology Solutions Company. Effective beginning December 31, 1998, we changed our fiscal year end from May 31 to December 31. The seven month transition period of June 1, 1998 through December 31, 1998 precedes the start of the new fiscal year. References in this section to a fiscal year correspond to the fiscal year ended May 31. OVERVIEW Our revenues consist of fees generated for professional services and support services, as well as license revenues generated from sales of in-house developed software, all of which we collectively sell as solutions to our customers. To date, revenues from software have not exceeded 3.0% of our total revenues in any quarter and were 1.4% and 1.0% of our total revenues for the years ended December 31, 1999 and 1998, respectively. We expect this split of revenues between professional services and software to remain relatively constant in the foreseeable future. Revenues from our support services were less than 1.5% of our total revenues for the years ended December 31, 1999 and 1998. Our revenues from support services may increase in the future. In addition, we intend to offer hosting services for our loyalty solutions, which would generate a recurring revenue stream. For selected clients, and after the completion of a detailed financial analysis, we may from time to time price engagements on a value-based model under which we reduce our billing rates or limit our fees in exchange for a share of the expected economic benefit to our clients of implementing our solutions. Our failure to accurately estimate variables in pricing engagements on these terms could reduce the profitability of, or result in a loss on, those projects and could damage our client relationships and our reputation. To date, we have provided professional services to our clients principally on a time and materials basis. We have, on limited occasions, contracted phases of our projects on a fixed fee basis. We expect that we will continue to provide most of our professional services on a time and materials basis. Under time and materials contracts, we recognize revenue as services are provided. We are generally reimbursed for reasonable expenses under our contracts. Our revenues from international operations represent revenues from engagements with our clients outside of the United States. Currently, we have international operations in Europe and Australia. We intend to expand our Australian operations and establish a presence in Asia Pacific. Revenues from international operations have made an increasing contribution to our total revenues and we anticipate that in the future our revenues from international operations will account for a greater percentage of our total revenues. International operations are subject to a number of additional risks and our international sales growth will be limited if we are unable to manage those risks. International operations represented 22.3% and 22.0% of revenues for the years ended December 31, 1999 and 1998, respectively. We typically experience seasonal fluctuations in our revenues and earnings on a global basis in the fourth quarter because of the reduced number of billing days due to holidays. In addition, we have experienced a slight decrease in revenues from our European operations in the third quarter because of extended vacation periods. Although those decreases in revenues have not been significant in the past, they may increase as we expand internationally. Revenues from our operations in the United Kingdom, Germany, Switzerland, France, Australia and Canada are denominated in local currencies such as Pound Sterling, Deutsche Marks, French Francs, Swiss Francs, Euros, Australian dollars and Canadian dollars. We believe that an increasing portion of our international revenues and costs will be denominated in foreign currencies in the future. Historically, we have 19 22 not experienced material fluctuations in our results of operations due to foreign currency exchange rate changes. We have a diversified client base and revenues from our top five and top 20 clients represented 22.2% and 54.8%, respectively, of revenues for the year ended December 31, 1999. No single client accounted for more than 10% of our total revenue in any quarter during those periods. We do not expect that our revenues from our top clients as a percentage of our total revenues will increase. Project personnel costs represent our most significant expense. These costs consist primarily of salaries, incentive compensation and employee benefits for company personnel available for client assignments as well as fees paid to subcontractors for work performed on our projects. Our revenues from using subcontractors were 3.8% and 2.7% of total revenues for the years ended December 31, 1999 and 1998, respectively. We anticipate that we will continue to use subcontractors from time to time, although we expect that the extent to which we use subcontractors will remain constant or decrease as a percentage of revenues. Gross profits represent our revenues less project personnel costs ("Gross Profit"). We anticipate that to the extent we have additional software and hosting services revenues, the margin on our Gross Profits will increase. Gross Profit margins are negatively impacted by several factors, including the use of subcontractors and non-billable time incurred by project personnel. Sales and marketing expenses consist primarily of salaries, incentive compensation and employee benefits for dedicated sales and marketing personnel in our marketing, business development and solutions marketing groups (prior to May 1999 this also included an allocation from Technology Solutions Company for their corporate sales and marketing). Sales and marketing expenses do not include sales and marketing expenses associated with other employees who are not part of the sales and marketing group. In addition, sales and marketing expenses include promotional and brand development costs, business development staff, recruiting costs, travel expenses and depreciation expenses. We expect that our sales and marketing expenses will increase as a percentage of revenues in the future as we invest in brand 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. Expenses of establishing our Loyalty Lab in fiscal year 1998 are included in research and development expenses beginning in the second quarter of 1998. Our Loyalty Lab is the center for our research and development activities. It is an important part of our strategy which we believe improves the effectiveness of our loyalty solutions. The objectives of our Loyalty Lab are to enhance our loyalty solutions, to allow us to work closely with emerging technology and to be a demonstration center for our clients' senior executives. Our research and development expenses as a percentage of revenues have remained constant at 3.5% for the years ended December 31, 1999, and 1998. We anticipate that research and development expenses will continue at approximately the same percentage of revenues for the foreseeable future. General and administrative support expenses consist of salaries, incentive compensation and benefits for our managerial and administrative staff (including senior and regional management) as well as provisions for doubtful receivables. The provisions for doubtful receivables have historically been approximately 1% of total revenues with the exception of the 1998 transition period. Because we established a provision for doubtful receivables related to revenues generated during the seven months ended December 31, 1998 otherwise referred to as the transition period (largely from clients of The Bentley Group, an acquisition), the total provisions for doubtful receivables rose to approximately 4% of total revenues. Other overhead expenses consist of employee costs for training, some travel expenses, laptop computer leases and other non-billable expenses not directly related to projects, sales or research and development. Technology Solutions Company corporate services allocation expenses relate to all shared services provided to us by Technology Solutions Company, including legal, information systems, finance and accounting, insurance, human resources, benefits administration, stockholder services and corporate managerial services. Technology Solutions Company corporate services allocation expenses also include the Chicago headquarters for all periods and all other directly allocated offices prior to April 30, 1999. In addition, labor costs associated with recruiting were also included in this expense item prior to April 30, 1999. From 20 23 January 1 through June 30, 2000, these services will be allocated as part of the Shared Services Agreement described in item 13 "Certain Relationships and Related Transactions" under "eLoyalty's Relationship with Technology Solutions Company After the Spin-Off -- Shared Services Agreement." Although we have never operated as a stand-alone company and have limited historical basis for our cost estimates, we anticipate our combined general and administrative and corporate services allocation expenses will decrease as a percentage of total revenues; however, we expect short term increases as we build our infrastructure to manage these functions as a separate company. We expect that by the third quarter of 2000 we will be able to provide for ourselves the services currently provided by Technology Solutions Company. After that time we expect that the costs for these services will be reflected in general and administrative expenses. Since May 1, 1999, our recruiting and some office expenses have been transferred from Technology Solutions Company corporate services allocation expenses to general and administrative expenses as the management of those functions was transferred to us from Technology Solutions Company. The expenses for facilities are attributable to facilities specifically allocated to us. Goodwill amortization expenses relate to our acquisitions of The Bentley Group in June 1997, Geising International in February 1997 and Aspen Consultancy Ltd. in May 1996. The goodwill amortization for The Bentley Group acquisition is approximately $1.0 million per quarter and is being amortized over a five year period (through 2002). The goodwill amortization associated with The Bentley Group acquisition currently represents approximately 80% of our total goodwill amortization costs. Historically, our effective tax rate has fluctuated significantly and for some periods our effective tax rate was unusually high. The high effective tax rates were due primarily to pre-tax losses being generated in low tax-rate jurisdictions and pre-tax earnings being generated in high tax-rate jurisdictions. Our effective tax rate of 49.9% and 61.0% for the years ended December 31, 1999 and 1998, respectively, was adversely impacted by nondeductible goodwill and expenses as well as foreign tax rate differences. As we implement tax planning strategies for our business as a stand-alone entity, we expect our effective tax rates to be less than these historical levels. YEAR ENDED DECEMBER 31, 1999 COMPARED WITH THE YEAR ENDED DECEMBER 31, 1998 This section discusses the year ended December 31, 1999 compared with the same period in 1998. The year ended December 31, 1999 was significant as we launched the eLoyalty brand and continued to focus on improving our operational management systems. We also increased our investment in research and development to increase our focus on the use of emerging technology. REVENUES Our revenues increased $40.8 million, or 38.7%, to $146.0 million in 1999 from $105.2 million in 1998. Revenues from professional services increased $38.0 million, or 36.5%, to $142.2 million in 1999 from $104.2 million in 1998. Revenues generated using subcontractors was 3.8% of revenues in 1999 compared to 1.6% of revenues in 1998. Revenues from software were $2.0 million in 1999, or 1.4% of revenues, compared to $1.0 million, or 1.0% of revenues, in 1998. Revenues from support increased to $1.8 million in 1999 from $0.0 million in 1998 as the Company launched our support services this year. The increase in our revenues of $40.8 million reflected increases in both the size and number of client projects as well as higher average billing rates. During 1999 our billable employees increased to 556 as of December 31, 1999, or 38.3%, from 402 for 1998. Revenues from Europe and Australia increased to approximately 17.1% of our total revenues during 1999, compared to 16.5% of total revenues in 1998. PROJECT PERSONNEL COSTS Our project personnel costs increased $21.7 million, or 42.9%, to $72.4 million in 1999 from $50.7 million in 1998. The increase in project personnel costs in 1999 was primarily due to an increase in the use of subcontractors that were required to meet demand. As a result our Gross Profit margin decreased slightly to 21 24 50.4% in 1999 from 51.8% in the comparable period in 1998. We expect that our use of subcontractors will decline as we operate as a separate business. SALES AND MARKETING EXPENSES Our sales and marketing expenses increased $4.8 million, or 98.3%, to $9.7 million in 1999 from $4.9 million in 1998. The increase in sales and marketing expenses was primarily the result of our decision to invest in brand building with respect to the launch of our new identity as eLoyalty and to formalize our business development group. We increased our sales and marketing staff with the launch of our solutions marketing group at the beginning of calendar year 1999. As a result of the foregoing, sales and marketing expenses increased as a percentage of total revenues to 6.6% in 1999 from 4.7% in 1998. RESEARCH AND DEVELOPMENT EXPENSES Our research and development expenses increased $1.5 million, or 40.1%, to $5.1 million in 1999 from $3.6 million in 1998. Research and development expenses remained constant as a percentage of revenues at 3.5% in both 1999 and 1998. In 1999 we substantially increased our investment in our Loyalty Lab by hiring additional developers and purchasing additional software and hardware. GENERAL AND ADMINISTRATIVE SUPPORT EXPENSES Our general and administrative support expenses increased $5.6 million, or 21.2%, to $31.9 million in 1999 from $26.3 million in 1998. General and administrative expenses decreased as a percentage of total revenues to 21.9% in 1999 from 25.0% in 1998. This decrease resulted from greater leverage of our regional management, particularly in Europe, who are responsible for general and administrative functions. This more than offset an increase in general and administrative support expenses resulting from the reallocation of recruiting and some office expenses from Technology Solutions Company corporate services allocation expenses as the management of those functions was transferred to us from Technology Solutions Company. In addition, we were able to eliminate the duplication of expenses associated with The Bentley Group. TECHNOLOGY SOLUTIONS COMPANY CORPORATE SERVICES ALLOCATION EXPENSES Technology Solutions Company corporate services allocation expenses increased $0.6 million, or 4.8%, to $13.4 million in 1999 from $12.8 million in 1998. Technology Solutions Company corporate services allocation expenses decreased as a percentage of total revenues to 9.2% in 1999 from 12.1% in 1998. This decrease was a result of the reallocation of recruiting and some office expenses into general and administrative support expenses as described above. GOODWILL AMORTIZATION Our goodwill amortization expenses increased $1.2 million or 31.7% to $5.0 million in 1999 from $3.8 million in 1998. The increase was due to contingent purchase price payments made in 1998 related to the acquisition of The Bentley Group. PROVISION FOR INCOME TAXES Income tax expense represents combined federal, state and foreign taxes. Our income tax provision increased to $4.0 million on pre-tax profits of $8.1 million in 1999, compared to $1.7 million on pre-tax profits of $2.7 million in 1998. Our effective tax rate was 49.9% for the 1999 and 61.0% for 1998. This decrease in the effective tax rate was primarily the result of a lower proportion of pre-tax earnings being generated in foreign high tax rate jurisdictions. 22 25 SEVEN MONTH TRANSITION PERIOD ENDED DECEMBER 31, 1998 COMPARED WITH THE SEVEN MONTH PERIOD ENDED DECEMBER 31, 1997 This section discusses the seven-month transition period ended December 31, 1998, resulting from our change from a May 31 fiscal year end to a December 31 fiscal year end beginning December 31, 1998. The 1998 transition period was significant for the Company due to a number of events including the integration of The Bentley Group, which was previously acquired by Technology Solutions Company, the integration of the telecom business unit of Technology Solutions Company and investments in Europe and Australia. During this period we established a direct sales force and began a dedicated sales effort in Europe and Australia. We also undertook a significant restructuring to support our focus on large multi-channel engagements. REVENUES Our revenues increased $20.7 million, or 47.4%, to $64.4 million in the seven month transition period ended December 31, 1998, from $43.7 million in the seven month transition period ended December 31, 1997. Revenues generated from using subcontractors was 2.2% of revenues in the transition period ended December 31, 1998 compared with 1.7% of revenues in the comparable period in the prior year. Revenues from sales of software were $1.0 million in the transition period ended December 31, 1998 representing 1.6% of revenues in that period. We had revenues of $0.2 million from sales of software in the transition period ended December 31, 1997. The increase in our revenues of $20.7 million reflected increases in both the size and number of client projects as well as higher average billing rates. The increase in revenues from our international operations also significantly contributed to this increase in revenue. In addition, The Bentley Group acquisition contributed approximately $7.8 million of revenues in the transition period ended December 31, 1997. PROJECT PERSONNEL COSTS Our project personnel costs increased $9.0 million, or 40.4%, to $31.3 million in the transition period ended December 31, 1998 from $22.3 million in the prior year period. The increase in project personnel costs was primarily due to an increase in billable employees, as well as higher salaries. Our Gross Profit margin increased to 51.4% for the transition period ended December 31, 1998 from 48.9% for the comparable period in 1997, principally due to higher utilization of project personnel. SALES AND MARKETING EXPENSES Our sales and marketing expenses increased $2.5 million, or 250.0%, to $3.5 million in the transition period ended December 31, 1998 from $1.0 million in the comparable period in the prior year. The increase in sales and marketing expenses was primarily the result of establishing our business development group in North America and beginning our sales activities in Europe and Australia. By the end of 1998 we had hired more than 10 people as dedicated business developers in North America. Sales and marketing expenses increased as a percentage of total revenues to 5.4% in the transition period ended December 31, 1998 from 2.3% in the comparable period in the prior year because of the significant growth in our new business regions. RESEARCH AND DEVELOPMENT EXPENSES Our research and development expenses increased $1.5 million, or 107.1%, to $2.9 million in the transition period ended December 31, 1998 from $1.4 million in the comparable period in the prior year. Research and development expenses increased as a percentage of total revenues to 4.5% in the transition period ended December 31, 1998 from 3.2% in the comparable period in the prior year. This increase resulted from the significant expansion of the scope and operations of our Loyalty Lab. We increased our development staff from nine employees to 28 employees and established quality assurance, documentation and full time research and demonstration groups to broaden our capabilities and leverage this investment throughout our business. In addition, the increase includes increased capitalized software costs that resulted in increased amortization expense in this period. 23 26 GENERAL AND ADMINISTRATIVE SUPPORT EXPENSES Our general and administrative support expenses increased $5.8 million, or 54.7%, to $16.4 million in the transition period ended December 31, 1998 from $10.6 million for the comparable period in the prior year. General and administrative expenses increased as a percentage of total revenues to 25.0% in the transition period ended December 31, 1998 from 24.3% in the comparable period in the prior year. We launched our operations group to manage utilization, hourly billing rate, revenue per billable employee, employee turnover and day-to-day project pipeline development. During this period, we also increased the support level for our operations in Europe and Australia. Prior to the end of 1998, The Bentley Group included their own operational and management infrastructure that duplicated our capabilities. By the end of the 1998 transition period we significantly eliminated the duplication and related expenses. In addition, we established a $2.7 million provision for uncollectible accounts receivable related to revenues generated during the transition period, largely from clients of The Bentley Group. TECHNOLOGY SOLUTIONS COMPANY CORPORATE SERVICES ALLOCATION EXPENSES Technology Solutions Company corporate services allocation expenses increased $2.2 million, or 40.0% to $7.7 million in the transition period ended December 31, 1998 from $5.5 million in the comparable period in the prior year. Technology Solutions Company corporate services allocation expenses decreased as a percentage of total revenue to 12.0% in the transition period ended December 31, 1998 from 12.7% in the comparable period in the prior year. This decrease was due to the transition of some management expenses related to The Bentley Group to general and administrative expenses. GOODWILL AMORTIZATION Our goodwill amortization expenses increased $0.6 million or 31.6%, to $2.5 million in the transition period ended December 31, 1998 from $1.9 million in the comparable period in the prior year. This increase was because of the contingent purchase price payments related to the acquisitions of The Bentley Group and Aspen Consultancy Ltd. PROVISION FOR INCOME TAXES Our income tax provision decreased to $0.4 million on a pre-tax loss of $0.1 million at the end of the transition period ended December 31, 1998 compared to $0.6 million on pre-tax profits of $0.9 million at the end of the comparable period in the prior year. This unusual income tax provision for the transition period ended December 31, 1998 resulted from the impact of nondeductible goodwill and expenses as well as foreign tax rate differences. During the seven months ended December 31, 1998, operations in some foreign jurisdictions incurred taxable losses while other foreign jurisdictions had taxable income. Since deferred tax assets are based on the individual tax jurisdictions in which eLoyalty operates, net operating losses were generated during the period. FISCAL 1998 COMPARED WITH FISCAL 1997 REVENUES Our revenues increased $41.3 million, or 95.6%, to $84.5 million in the fiscal year ended May 31, 1998 from $43.2 million in the fiscal year ended May 31, 1997. The increase in our revenues reflected increases in both the size and number of client projects. The Bentley Group acquisition contributed $16.4 million of revenues in fiscal year 1998. Our internal compound annual growth rate less the revenue associated with The Bentley Group acquisition was 57.6% for fiscal year 1998 compared with 62.8% compound annual growth rate for the previous year. PROJECT PERSONNEL COSTS Our project personnel costs increased $23.2 million, or 128.2%, to $41.3 million in fiscal 1998 from $18.1 million in fiscal 1997. The increase in project personnel costs in fiscal 1998 was primarily due to an 24 27 increase in billable employees, as well as higher salaries. Our Gross Profit margin decreased to 51.1% in fiscal 1998 from 58.1% in fiscal 1997. This decrease in Gross Profit margin resulted from a substantial increase in our available billable employees who we were not able to immediately deploy. The increase in available billable resources was necessary to respond to the growing demand in our North American business. SALES AND MARKETING EXPENSES Our sales and marketing expenses increased $0.7 million, or 41.2%, to approximately $2.4 million in fiscal 1998 from $1.7 million in fiscal 1997. The increase in sales and marketing expenses was primarily the result of our decision to expand our sales and marketing effort in North America. Sales and marketing expenses decreased as a percentage of total revenues to 2.9% in fiscal 1998 from 3.9% in fiscal 1997. This decrease reflected the maturity of our North American business and our ability to leverage our existing sales and marketing functions in fiscal 1998. RESEARCH AND DEVELOPMENT EXPENSES Our research and development expenses increased $0.7 million, or 41.2%, to approximately $2.4 million in fiscal 1998 from $1.7 million in fiscal 1997. Research and development expenses decreased as a percentage of total revenues to 2.8% in fiscal 1998 from 3.9% in fiscal 1997. This decrease resulted from our significant revenue growth in fiscal 1998 and the redeployment of our development staff as billable employees to meet the demands of our expanding North American business. GENERAL AND ADMINISTRATIVE SUPPORT EXPENSES Our general and administrative support expenses increased $8.7 million, or 75.7%, to $20.2 million in fiscal 1998 from $11.5 million in fiscal 1997. General and administrative support expenses decreased as a percentage of total revenues to 24.0% in fiscal 1998 from 26.6% in fiscal 1997. This decrease also reflects the generation of additional revenue in North America without a proportional increase in general and administrative support expenses. TECHNOLOGY SOLUTIONS COMPANY CORPORATE SERVICES ALLOCATION EXPENSES Technology Solutions Company corporate services allocation expenses increased $5.7 million, or 114.0%, to $10.7 million in fiscal 1998 from $5.0 million in fiscal 1997. Technology Solutions Company corporate services allocation expenses increased slightly as a percentage of total revenues at 12.6% in fiscal 1998 and 11.6% in fiscal 1997. This increase was as a result of Technology Solutions Company's international expansion. GOODWILL AMORTIZATION Our goodwill amortization expenses increased $2.8 million to $3.2 million in fiscal 1998 from $0.4 million in fiscal 1997. The increase in goodwill amortization as a percentage of revenues to 3.8% in fiscal 1998 from 0.9% in fiscal 1997 was primarily a result of The Bentley Group acquisition in June 1997. The Company adopted the disclosure-only provisions of the Financial Accounting Standards Board Statement of Financial Accounting Standards No. 123. LIQUIDITY AND CAPITAL RESOURCES Our principal capital requirements are to fund working capital needs and capital expenditures in order to support revenue growth. Historically, these capital requirements have been satisfied by funds provided by Technology Solutions Company. Technology Solutions Company has performed cash management services for us, whereby our cash flow was directed to Technology Solutions Company and Technology Solutions Company provided cash to us to fund our operating expenses and capital expenditures. Following the spin-off, we no longer participate in Technology Solutions Company's cash management system and Technology Solutions Company no longer provide funds to us to finance our operations, provide guarantees (except as described below) of our financial or other obligations. 25 28 In the year ended December 31, 1999, net cash used in operating activities totaled $11.0 million. Cash was provided by $4.1 million of net income, $6.4 million from depreciation and amortization and $4.5 million related to an increase in accrued compensation. This was offset by an $21.5 million increase in receivables. The increase in receivables was mainly due to growth in revenues. Receivables related to amounts billed to clients increased from $23.7 million to $39.6 million, or 66.6% from December 31, 1998 to December 31, 1999. Unbilled Revenues increased from $4.3 million to $6.6 million or 51.7% from December 31, 1998 to December 31, 1999. The increase in Unbilled Revenues resulted from an increase in contracts that were invoiced based on the completion of phases of a project as opposed to our standard monthly billing. This trend may continue in the future. For the twelve months ended December 31, 1998, net cash used in operating activities was $3.8 million, driven by $1.1 million of net income and $4.9 million of depreciation and amortization and offset by a $11.1 million increase in receivables. Capital expenditures for the year ended December 31, 1999 were $2.2 million for computer, furniture, equipment and leasehold improvements. Capital expenditures for 2000 are budgeted at $15-$20 million. The amount may vary as leases are being pursued as a possible alternative to purchasing assets. Of this amount approximately $12-$15 million is related to infrastructure for facilities and information technology and $3-$5 million is expected to be invested in the Loyalty Lab, Hosting and Support. In connection with the spin-off the Company received an additional $20 million of cash from Technology Solutions Company as part of the reorganization agreement. Also, the Company received $8.4 million of proceeds from sales of 2.5 million shares of common stock to certain venture capital investors. See also Note 13 to the Combined Financial Statements (Item 8). Also, in connection with the spin-off, we have entered into a $10 million revolving credit facility with Bank of America to provide the cash needed for short term operating obligations. Pursuant to the Reorganization Agreement and certain other agreements relating to the spin-off, Technology Solutions Company has agreed to guarantee obligations under the facility through December 31, 2000. The borrowings under the revolving credit facility bear interest at a rate of LIBOR plus .75%. The credit revolving facility contains customary representations, warranties, covenants and default provisions, including working capital commitments and debt to equity ratios. We believe that current cash and cash equivalents, the revolving credit facility and cash flow from operations should be sufficient to satisfy our cash requirements for the foreseeable future. Also, we intend on obtaining additional equity financing in 2000 through a public offering. In addition, we may obtain additional capital through a private placement of equity with strategic or other investors or through additional debt financing. We believe that in the future we will be able to access the capital markets on terms and in amounts that will be satisfactory to us, although there can be no assurance in that regard. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK We provide our solutions to clients in a number of countries including the United States, Canada, United Kingdom, Germany, France, Switzerland and Australia. For the years ended December 31, 1999 and 1998, 22.3% and 22.0%, respectively, of our revenues were denominated in foreign currencies such as Pound Sterling, Deutsche Marks, French Francs, Swiss Francs, Euros, Australian dollars and Canadian dollars. We believe that an increasing portion of our international revenues and costs will be denominated in foreign currencies in the future. As a result of our exposure to foreign currencies, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in those foreign markets. Revenues of our foreign subsidiaries are currently realized or received in U.S. dollars or in various foreign currencies. To the extent that we bill clients in a currency other than their local currency, exchange rate fluctuations that strengthen the currency in which we bill relative to their local currency could make our services less competitive to those clients. Historically, we have not experienced material fluctuations in our results of operations due to foreign currency exchange rate changes. 26 29 RECENT ACCOUNTING PRONOUNCEMENTS On June 15, 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133, as amended, is effective for fiscal years beginning after June 15, 2000 (January 1, 2001 for eLoyalty). SFAS No. 133 requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction. We anticipate that the adoption of SFAS No. 133 will not have a significant effect on our results of operations or financial position. YEAR 2000 ISSUE The Company did not experience any significant Year 2000 disruptions and none of the Company's suppliers or vendors have experienced Year 2000 disruptions that have had a significant impact on the Company. 27 30 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
PAGE ---- FINANCIAL STATEMENTS Report of Independent Accountants........................... 29 Combined Balance Sheets as of December 31, 1999 and 1998.... 30 Combined Statements of Operations for the years ended December 31, 1999 and 1998 (unaudited), the seven month period from June 1, 1998 to December 31, 1998, and for each of the two years in the period ended May 31, 1998.... 31 Combined Statements of Cash Flows for the years ended December 31, 1999 and 1998 (unaudited), the seven month period from June 1, 1998 to December 31, 1998, and for each of the two years in the period ended May 31, 1998.... 32 Combined Statements of Changes in Stockholder's Equity and Comprehensive Income (Loss) for the year ended December 31, 1999, the seven month period ended December 31, 1998, and for each of the two years in the period ended May 31, 1998...................................................... 33 Notes to Combined Financial Statements...................... 34
FINANCIAL STATEMENT SCHEDULE 48 Schedule II -- Valuation and Qualifying Accounts............
28 31 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of eLoyalty Corporation: In our opinion, the combined financial statements listed in the accompanying index present fairly, in all material respects, the financial position of eLoyalty Corporation (the "Company") as of December 31, 1999 and 1998, and the results of its operations and its cash flows for the year ended December 31, 1999, for the seven month period from June 1, 1998 to December 31, 1998 and for each of the two years in the period ended May 31, 1998, in conformity with accounting principles generally accepted in the United States. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related combined financial statements. These financial statements and financial statement schedule are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PricewaterhouseCoopers LLP February 15, 2000 Chicago, Illinois 29 32 eLOYALTY CORPORATION COMBINED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) ASSETS
DECEMBER 31, ----------------- 1999 1998 ------- ------- CURRENT ASSETS: Cash and cash equivalents................................... $13,462 $ 4,411 Marketable securities....................................... 7,175 4,486 Receivables, net............................................ 44,056 25,443 Deferred income taxes....................................... 9,057 4,711 Prepaid expenses............................................ 3,093 2,175 Other current assets........................................ 1,072 1,021 ------- ------- Total current assets.............................. 77,915 42,247 COMPUTERS, FURNITURE AND EQUIPMENT, NET..................... 2,284 1,581 GOODWILL, NET............................................... 12,129 17,201 DEFERRED INCOME TAXES....................................... 2,387 1,054 LONG-TERM RECEIVABLES AND OTHER............................. 1,888 1,821 ------- ------- Total assets...................................... $96,603 $63,904 ======= ======= LIABILITIES AND STOCKHOLDER'S EQUITY CURRENT LIABILITIES: Accounts payable............................................ $ 640 $ 994 Accrued compensation and related costs...................... 11,687 7,304 Deferred compensation....................................... 7,175 4,486 Other current liabilities................................... 3,486 3,232 ------- ------- Total current liabilities......................... 22,988 16,016 ------- ------- COMMITMENTS AND CONTINGENCIES............................... -- -- STOCKHOLDER'S 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; 41,400,000 shares issued and outstanding as of December 31, 1999.................................................. 414 -- Additional paid-in capital.................................. 963 -- Net advances from Technology Solutions Company.............. 74,048 48,475 Accumulated other comprehensive loss........................ (847) (587) Unearned compensation....................................... (963) -- ------- ------- Total stockholder's equity........................ 73,615 47,888 ------- ------- Total liabilities and stockholder's equity........ $96,603 $63,904 ======= =======
The accompanying Notes to Combined Financial Statements are an integral part of this financial information. 30 33 eLOYALTY CORPORATION COMBINED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
FOR THE SEVEN MONTH FOR THE YEARS ENDED PERIOD FROM FOR THE YEARS ENDED DECEMBER 31, JUNE 1 TO MAY 31, ---------------------- DECEMBER 31, ------------------- 1999 1998 1998 1998 1997 -------- ----------- ------------ -------- -------- (UNAUDITED) REVENUES.................................................... $146,003 $105,235 $ 64,415 $ 84,488 $ 43,181 Project personnel......................................... (72,412) (50,687) (31,302) (41,329) (18,078) -------- -------- -------- -------- -------- GROSS PROFIT................................................ 73,591 54,548 33,113 43,159 25,103 -------- -------- -------- -------- -------- OTHER COSTS AND EXPENSES: Sales and marketing....................................... 9,703 4,894 3,456 2,429 1,663 Research and development.................................. 5,093 3,635 2,889 2,383 1,689 General and administrative................................ 31,916 26,326 16,438 20,216 11,539 Technology Solutions Company corporate services allocation.............................................. 13,378 12,769 7,698 10,671 5,028 Goodwill amortization..................................... 4,996 3,794 2,450 3,201 376 Equity in net loss of unconsolidated investee............. 463 412 412 -- -- -------- -------- -------- -------- -------- 65,549 51,830 33,343 38,900 20,295 -------- -------- -------- -------- -------- OPERATING INCOME (LOSS)..................................... 8,042 2,718 (230) 4,259 4,808 -------- -------- -------- -------- -------- OTHER INCOME (EXPENSE): Net investment income..................................... 127 95 116 68 15 Interest expense.......................................... (72) (74) (31) (92) -- -------- -------- -------- -------- -------- 55 21 85 (24) 15 -------- -------- -------- -------- -------- INCOME (LOSS) BEFORE INCOME TAXES........................... 8,097 2,739 (145) 4,235 4,823 INCOME TAX PROVISION........................................ 4,039 1,672 398 2,022 1,897 -------- -------- -------- -------- -------- NET INCOME (LOSS)........................................... $ 4,058 $ 1,067 $ (543) $ 2,213 $ 2,926 ======== ======== ======== ======== ======== Basic net income (loss) per common share.................... $ 0.10 $ 0.03 $ (0.01) $ 0.05 $ 0.07 Diluted net income (loss) per common share.................. $ 0.09 $ 0.02 $ (0.01) $ 0.05 $ 0.06 Shares used to calculate basic net income (loss) per share (in millions)............................................. 41.4 41.4 41.4 41.4 41.4 Shares used to calculate diluted net income (loss) per share (in millions)............................................. 44.2 43.1 41.4 46.8 46.6
The accompanying Notes to Combined Financial Statements are an integral part of this financial information. 31 34 eLOYALTY CORPORATION COMBINED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
FOR THE SEVEN MONTH FOR THE YEARS ENDED PERIOD FROM FOR THE YEARS ENDED DECEMBER 31, JUNE 1 TO MAY 31, ---------------------- DECEMBER 31, -------------------- 1999 1998 1998 1998 1997 -------- ----------- ------------ --------- -------- (UNAUDITED) CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss).............................. $ 4,058 $ 1,067 $ (543) $ 2,213 $ 2,926 Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities: Depreciation and amortization................ 6,355 4,947 3,509 3,874 617 Provisions for doubtful receivables.......... 2,059 2,684 2,652 531 453 Equity losses of unconsolidated investee..... 463 412 412 -- -- Deferred income taxes........................ (5,763) (4,212) (3,432) (2,118) (315) Changes in assets and liabilities: Receivables................................ (21,496) (10,811) (4,197) (10,217) (3,453) Purchases of trading securities related to deferred compensation program........... (2,689) (1,651) (830) (2,096) (799) Other current assets....................... (1,038) (995) 278 (1,079) (1,177) Accounts payable........................... (313) 520 647 (1,184) 229 Accrued compensation and related costs..... 4,517 1,838 776 2,674 (217) Deferred compensation funds from employees............................... 2,689 1,651 830 2,096 799 Other current liabilities.................. 653 1,002 538 (2,383) 1,335 Other assets............................... (536) (216) (11) (815) (339) -------- -------- ------- -------- ------- Net cash (used in) provided by operating activities............................ (11,041) (3,764) 629 (8,504) 59 -------- -------- ------- -------- ------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures........................... (2,175) (1,174) (570) (1,065) (182) Investment in unconsolidated investee.......... -- -- (875) -- -- Acquired businesses............................ -- (7,911) (6,625) (10,741) (940) -------- -------- ------- -------- ------- Net cash used in investing activities... (2,175) (9,085) (8,070) (11,806) (1,122) -------- -------- ------- -------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Transfers from Technology Solutions Company.... 21,929 12,366 7,777 21,608 5,182 -------- -------- ------- -------- ------- Net cash provided by financing activities............................ 21,929 12,366 7,777 21,608 5,182 -------- -------- ------- -------- ------- EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS.................................... 338 (236) (651) (702) (310) -------- -------- ------- -------- ------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS.................................... 9,051 (719) (315) 596 3,809 CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD... 4,411 5,130 4,726 4,130 321 -------- -------- ------- -------- ------- CASH AND CASH EQUIVALENTS, END OF PERIOD......... $ 13,462 $ 4,411 $ 4,411 $ 4,726 $ 4,130 ======== ======== ======= ======== =======
The accompanying Notes to Combined Financial Statements are an integral part of this financial information. 32 35 eLOYALTY CORPORATION COMBINED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY AND COMPREHENSIVE INCOME (LOSS) (IN THOUSANDS, EXCEPT SHARE DATA)
ADVANCES ACCUMULATED (TO) FROM OTHER COMMON STOCK ADDITIONAL TECHNOLOGY COMPREHENSIVE TOTAL ------------------- PAID IN SOLUTIONS INCOME UNEARNED STOCKHOLDER'S SHARES AMOUNT CAPITAL COMPANY (LOSS) COMPENSATION EQUITY ---------- ------ ---------- ---------- ------------- ------------ ------------- Balance, May 31, 1996... -- -- -- $ 9,312 -- -- $ 9,312 ---------- ---- ---- ------- ----- ----- ------- Net income.............. 2,926 2,926 Foreign currency translation........... $(273) (273) ------- Comprehensive income.. 2,653 Net transfers from Technology Solutions Company............... 5,182 5,182 ---------- ---- ---- ------- ----- ----- ------- Balance, May 31, 1997... -- -- -- 17,420 (273) -- 17,147 ---------- ---- ---- ------- ----- ----- ------- Net income.............. 2,213 2,213 Foreign currency translation........... (75) (75) ------- Comprehensive income.. 2,138 Net transfers from Technology Solutions Company............... 21,608 21,608 ---------- ---- ---- ------- ----- ----- ------- Balance, May 31, 1998... -- -- -- 41,241 (348) -- 40,893 ---------- ---- ---- ------- ----- ----- ------- Net loss................ (543) (543) Foreign currency translation........... (239) (239) ------- Comprehensive loss.... (782) Net transfers from Technology Solutions Company............... 7,777 7,777 ---------- ---- ---- ------- ----- ----- ------- Balance, December 31, 1998.................. -- -- -- 48,475 (587) -- 47,888 ---------- ---- ---- ------- ----- ----- ------- Net income.............. 4,058 4,058 Foreign currency translation........... ..... (260) (260) ------- Comprehensive income.. 3,798 Net transfers from Technology Solutions Company............... 21,929 21,929 Issuance of common stock................. 41,400,000 $414 (414) Issuance of compensatory stock options......... $963 $(963) -- ---------- ---- ---- ------- ----- ----- ------- Balance, December 31, 1999.................. 41,400,000 $414 $963 $74,048 $(847) $(963) $73,615 ========== ==== ==== ======= ===== ===== =======
The accompanying Notes to Combined Financial Statements are an integral part of this financial information. 33 36 eLOYALTY CORPORATION NOTES TO COMBINED FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) NOTE 1 -- THE COMPANY eLoyalty Corporation ("eLoyalty" or the "Company") is a leading global information technology services company focused on providing enterprise-wide solutions across the Internet, e-mail, web-chat, telephone and fax that are designed to result in lasting and profitable customer relationships for its clients. eLoyalty defines this new category of solutions as loyalty solutions. eLoyalty's clients generally are located throughout the United States and in Europe, Canada and Australia. On February 15, 2000 Technology Solutions Company ("TSC" or the "Parent") successfully completed its spin-off of its eLoyalty division into a separate publicly traded company (the "Distribution"). To effectuate the transaction, the Board of Directors of Technology Solutions Company declared a dividend payable to the holders of record of Technology Solutions Company as of February 9, 2000, based upon a ratio of one share of the Company's common stock, par value of $.01 per share for every one share of Technology Solutions Common Stock owned on the record date. Effective February 15, 2000 all of the outstanding shares of Common Stock were distributed to Technology Solutions Company stockholders. eLoyalty and TSC have entered into certain agreements governing various interim and ongoing relationships between eLoyalty and TSC before and after the Distribution. The financial information included herein may not necessarily reflect the combined results of operations, financial position, changes in stockholder's equity and cash flows of eLoyalty in the future or what they would have been had it been a separate, stand-alone entity during the periods presented. NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation -- The combined financial statements reflect the results of operations, financial position, changes in stockholder's equity and cash flows of the businesses that were transferred to eLoyalty from TSC in the Distribution (the "eLoyalty Businesses") as if eLoyalty were a separate entity for all periods presented. The combined financial statements have been prepared using the historical basis in the assets and liabilities and historical results of operations related to the eLoyalty Businesses as they were operated within TSC. The combined statements of operations include all of the related costs of doing business including an allocation of certain general corporate expenses of TSC which were not directly related to the Company's operations, including legal, information systems, finance, insurance, human resources, benefits administration, stockholders' services and corporate management services. These costs were allocated to eLoyalty primarily on a proportional cost allocation method based on revenues and headcount. Management believes these allocations were made on a reasonable basis. Fiscal Year Change -- On November 22, 1998, TSC's Board of Directors voted to change the fiscal year of TSC from a fiscal year ending on May 31 in each year to a calendar year ending on December 31 in each year. The seven month transition period of June 1, 1998 through December 31, 1998 (transition period) precedes the start of the new fiscal year. The unaudited financial information for the year ended December 31, 1998 is presented for comparative purposes and includes any adjustments (consisting of normal, recurring adjustments) which are, in the opinion of management, necessary for a fair presentation. Revenue Recognition -- eLoyalty derives substantially all of its revenues from professional services. eLoyalty provides professional services, including support, primarily on a time and materials basis. Although eLoyalty occasionally performs certain projects on a fixed fee basis, the total portion of combined net revenues derived from fixed fee engagements is not significant. For time and materials engagements, eLoyalty recognizes revenues as services are performed, based on hourly billing rates. For fixed fee engagements, revenues are recognized under the percentage-of-completion basis of accounting, based on the ratio of costs incurred to total estimated costs. From time to time, eLoyalty uses subcontractors to supplement its resources 34 37 eLOYALTY CORPORATION NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) in client engagements. Revenues generated through subcontractors are recognized based on the terms of the related project (time and materials or fixed fee), and the related subcontractor costs are included in project personnel expense as incurred. eLoyalty also derives revenues from in-house developed software. Software license fee revenues are recognized when persuasive evidence of an arrangement exists, delivery has occurred, the license fee is fixed and determinable and the collection of the fee is probable. Fees from licenses sold together with consulting services are generally recognized upon delivery provided that the above criteria have been met and payment of the license fees is not dependent upon the performance of the consulting services. In those instances when it is determined that the payment of the license fee is dependent upon the performance of consulting services, both the license and consulting fees are recognized under the percentage of completion method of contract accounting. Revenues from post-contract support are recognized ratably over the term of the maintenance contract on a straight-line basis. To date, software revenues have not exceeded 3% of total revenues for any quarterly period and represented 1.4% and 1.0% of our total revenues for the years ended December 31, 1999 and 1998, respectively. Out-of-pocket expenses (travel, lodging, etc.) charged on client engagements are presented net of amounts billed to clients as general and administrative expense in the accompanying combined statements of operations. Engagements are performed in phases. Losses on engagements, if any, are reserved in full when determined. Project Personnel Costs -- eLoyalty expenses the cost of project personnel as incurred. Project personnel costs consist primarily of salaries, incentive compensation and employee benefits for eLoyalty personnel available for client assignments, and fees paid to subcontractors for work performed on client projects. Cash and Cash Equivalents -- eLoyalty considers all highly liquid investments readily convertible into cash (with original maturities of three months or less) to be cash equivalents. These short-term investments are carried at cost plus accrued interest, which approximates market. Marketable Securities -- eLoyalty's marketable securities consist of investments related to TSC's executive deferred compensation plan (see Note 4) and are classified as trading securities, with unrealized gains and losses included in eLoyalty's combined statements of operations. Realized gains or losses are determined on the specific identification method. The Company recognized net gains of $730, $167, $823 and $183 for the year ended December 31, 1999, the seven month transition period and December 31, 1998 and the fiscal years ended May 31, 1998 and 1997, respectively. Since the trading securities relate to the Company's executive deferred compensation plan, a corresponding charge to earnings is included in the Statements of Operations to recognize the Company's increase liability for the deferred compensation plan. Computers, Furniture and Equipment -- Computers, furniture and equipment are carried at cost and depreciated on a straight-line basis over their estimated useful lives. Useful lives generally are five years or less. Maintenance and repair costs are expensed as incurred. The cost and related accumulated depreciation of assets sold or disposed of are moved from the account and resulting gain or loss is included in operations. The carrying value of computers, furniture and equipment is periodically reviewed to asses recoverability based on future cash flows. Goodwill -- Goodwill is amortized on a straight-line basis, typically over a five-year period. Accumulated amortization of goodwill as of December 31, 1999 and 1998 and May 31, 1998 and 1997 was $10,971, $6,042, $3,573 and $371, respectively. The carrying value of goodwill is periodically reviewed to assess recoverability based on undiscounted cash flows. Research and Development Costs -- Research and development costs are expensed as incurred, except for costs incurred for the development of computer software that will be sold. Research and development expenses relate primarily to the dedicated research and development facility maintained by eLoyalty, and consist primarily of salaries, incentive compensation and employee benefits costs for dedicated personnel, occupancy costs, staff recruiting costs, administrative costs, travel expenses and depreciation. 35 38 eLOYALTY CORPORATION NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) Software Development Costs -- eLoyalty capitalizes software development costs once technological feasibility is established and prior to general release. Amortization is computed as the greater of the amount computed using the (a) ratio of current revenues to the total current and anticipated future revenues or (b) the straight-line method over the estimated economic life of the product. There are no capitalized software development costs included on eLoyalty's combined balance sheets as of December 31, 1999 and 1998. Amortization expense associated with software development costs was $447, $354 and $110 for the seven month transition period ended December 31, 1998 and the fiscal years ended May 31, 1998 and 1997, respectively. There was no amortization expense of software development costs during the year ended December 31, 1999. Stockholder's Equity -- Stockholder's equity includes common stock issued to TSC, advances (to) from TSC, other comprehensive income (loss) related to foreign currency translation and unearned compensation related to stock-based compensation. Advances from TSC represent transfers to eLoyalty primarily for operations and working capital requirements, offset by cash collected by TSC. The balances are primarily the result of eLoyalty's participation in TSC's central cash management system, wherein all of eLoyalty's domestic cash receipts are collected by TSC and all domestic cash disbursements are funded by TSC. Other transactions include the Company's share of TSC's combined income tax liability and other administrative expenses incurred by TSC on behalf of eLoyalty. Such amounts do not have repayment terms and do not bear interest. Earnings (Loss) Per Common Share -- In December 1999, eLoyalty issued 41.4 million shares to TSC. Basic earnings (loss) per share have been computed by dividing the net income/(loss) for each period presented by the 41.4 million shares. Diluted net earnings per share was computed by dividing the net income/(loss) for each period presented by the 41.4 million shares plus the estimated dilutive effect of common stock equivalents using the "treasury stock" method. For the seven month transition period ended December 31, 1998, common stock equivalents were not included in diluted loss per share as they were anti- dilutive. The Company's common stock equivalents relate to stock options. See Note 8, "Stock Options" for a discussion of stock options. Foreign Currency Translation -- The functional currencies for eLoyalty's foreign subsidiaries are their local currencies. All assets and liabilities of foreign subsidiaries are translated to U.S. dollars at end of period exchange rates. The resulting translation adjustments are recorded as a component of stockholder's equity. Income and expense items are translated at average exchange rates prevailing during the period. Gains and losses from foreign currency transactions of these subsidiaries are included in the combined statements of income. Fair Value of Financial Instruments -- The carrying values of current assets and liabilities and long-term receivables approximated their fair values as of December 31, 1999 and 1998, respectively. Concentration of Credit Risk -- No client accounted for 10 percent or more of revenues during the year ended December 31, 1999, the transition period ended December 31, 1998, fiscal 1998 or fiscal 1997. No client accounted for 10 percent or more of gross accounts receivables as of December 31, 1999 or December 31, 1998. Stock-Based Compensation -- eLoyalty accounts for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. Compensation costs for employee stock options is measured as the excess, if any, of the fair value of the Company's stock or TSC's stock at the date of grant over the amount an employee must pay to acquire the stock. In the event stock options are granted at a price lower than the fair value on the date of grant, the difference is recorded as unearned compensation. Unearned compensation is 36 39 eLOYALTY CORPORATION NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) amortized over the vesting period of the stock options. The unearned compensation recorded at December 31, 1999 relates solely to eLoyalty stock-based awards. Income Taxes -- Historically, eLoyalty's results have been included in TSC's consolidated federal and state income tax returns. The income tax provision is calculated and deferred tax assets and liabilities are recorded as if eLoyalty had operated as an independent entity. eLoyalty uses an asset and liability approach to financial accounting and reporting for income taxes. Deferred income taxes are provided when tax laws and financial accounting standards differ with respect to the amount of income for a year and the basis of assets and liabilities and for tax loss carryforwards. eLoyalty does not provide U.S. deferred income taxes on earnings of foreign subsidiaries which are expected to be indefinitely reinvested. New Accounting Standards -- On June 15, 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133, as amended, is effective for fiscal years beginning after June 15, 2000 (January 1, 2001 for eLoyalty). SFAS No. 133 requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction. eLoyalty anticipates that the adoption of SFAS No. 133 will not have a significant effect on eLoyalty's results of operations or its financial position. Estimates and Assumptions -- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, the disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. NOTE 3 -- ACQUISITIONS/INVESTMENTS In June 1997, eLoyalty acquired The Bentley Group, Inc. (Bentley), a business and operations consulting firm. Total consideration aggregated $17,500, including cash of $12,000, 44,303 shares of TSC Common Stock and stock options. Goodwill of approximately $18,100 resulted from the Bentley acquisition and is being amortized over five years. In February 1997, eLoyalty acquired Geising International, a German-based business consulting firm. Total consideration aggregated $1,400, including cash of $1,000 and 37,962 shares of TSC's Common Stock. Goodwill of approximately $1,000 resulted from the Geising International acquisition and is being amortized over five years. In May 1996, eLoyalty acquired Aspen Consultancy Ltd., (Aspen). Aspen is a United Kingdom-based consulting firm. Total cash consideration aggregated $3,400. Goodwill of approximately $3,500 resulted from the Aspen acquisition and is being amortized over a five year period. These acquisitions have been accounted for under the purchase method and accordingly their results have been included in eLoyalty's results since the date of acquisition. In August 1998, eLoyalty invested $875 in NexCen Technologies, Inc. (NexCen), a development stage enterprise. eLoyalty's investment in NexCen is comprised of both Series A redeemable convertible preferred stock ("Series A Stock") and warrants to purchase Series A Stock at an exercise price of $.01 per share ("Warrants"). Each share of Series A Stock in convertible into common stock at the option of eLoyalty under a formula which currently results in a 1-for-1 conversion rate. Each share of Series A Stock is entitled to the number of votes equal to that number of shares of common stock into which shares of Series A Stock can be converted. 37 40 eLOYALTY CORPORATION NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) Assuming the conversion of all of the Series A Stock and Warrants into common stock, eLoyalty's ownership in NexCen would approximate 27 percent. eLoyalty has also elected one member to the NexCen Board of Directors. eLoyalty has concluded that it has the ability to exercise significant influence over the operating and financial policies of NexCen and thus, has accounted for its investment under the equity method of accounting. Notwithstanding the fact that eLoyalty does not own any of the common stock of NexCen, eLoyalty recorded 60 percent of NexCen's losses until such time that eLoyalty had reduced the carrying value of its investment in NexCen to $0. NexCen, which was incorporated in July 1998, has funded its operating losses solely through the sale of the Series A Stock and Warrants. The recording of 60 percent of the losses represents eLoyalty's share of NexCen's total Series A Stock and Warrants. As of December 31, 1999, the carrying value of eLoyalty's investment in NexCen was $0. NOTE 4 -- RELATED PARTY TRANSACTIONS Employees of eLoyalty were eligible to participate in the TSC 401(k) Savings Plan (the "Plan") through the date of Distribution. The Plan allows employees to contribute up to 15 percent of their annual compensation, subject to Internal Revenue Service statutory limitations. Contributions to the Plan are made at the discretion of TSC and the related expense is allocated to eLoyalty based on the actual employees covered. Plan expense allocated to eLoyalty by TSC totaled $1,131 in the year ended December 31, 1999, $487 in the seven-month period ended December 31, 1998 and $470 and $336 in the years ended May 31, 1998 and 1997, respectively. In connection with the Distribution the Company has established a 401(k) Savings Plan ("eLoyalty Plan") and transferred all Plan assets related to eLoyalty employees into the eLoyalty Plan. eLoyalty participated in TSC's nonqualified executive deferred compensation plan through the date of Distribution. All eLoyalty executives (defined as Vice Presidents and above) were eligible to participate in this voluntary program which permits participants to elect to defer receipt of a portion of their compensation. Deferred contributions and investment earnings are payable to participants upon various specified events, including retirement, disability or termination. The accompanying combined balance sheets include the deferred compensation liability, including investment earnings thereon, owed to participants. The accompanying combined balance sheets also include eLoyalty's portion of the investments, classified as trading securities, purchased by TSC with the deferred funds. These investments remain assets of eLoyalty and are available to the general creditors of eLoyalty in the event of eLoyalty's insolvency. eLoyalty implemented a similar plan in connection with the Distribution. Project expenses have been recorded on an individual project basis. The financial statements include expenses which have been allocated to eLoyalty by TSC on a specific identification basis. Further, eLoyalty shares certain employees and other resources with TSC. Allocations from TSC for indirect expenses for such shared resources have been made primarily on a proportional cost allocation method based on revenues and headcount. Management believes these allocations are reasonable and that such expenses would not have differed materially had eLoyalty operated on a stand-alone basis for all periods presented. Such allocations of general corporate overhead expenses are included in eLoyalty's combined statement of operations as follows:
FOR THE YEAR FOR THE SEVEN MONTH FOR THE YEAR ENDED PERIODS FROM JUNE 1 ENDED MAY 31, DECEMBER 31, TO DECEMBER 31, ---------------- 1999 1998 1998 1997 ------------ ------------------- ------- ------ Sales and marketing........................................ $ 795 $ 731 $ 972 $ 586 Technology Solutions Company corporate services allocation............................................... 13,378 7,698 10,671 5,028 ------- ------ ------- ------ Total allocated general corporate overhead........ $14,173 $8,429 $11,643 $5,614 ======= ====== ======= ======
38 41 eLOYALTY CORPORATION NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) On November 12, 1998, TSC made a loan of $1,200 to Mr. Conway with a five-year term that, to the extent not forgiven in whole or in part as described below, is payable on demand upon the cessation of Mr. Conway's employment with TSC or its affiliates, including eLoyalty. The loan bears interest at the rate of 4.5% per annum and, so long as Mr. Conway remains employed by eLoyalty, the principal amount of the loan (and interest accrued thereon) is being forgiven over a five-year period as follows: 25% of the principal amount was forgiven on November 12, 1999; $25 in principal per month is being forgiven for the next twelve months; $20 in principal per month will be forgiven for the next twenty-four months; and $10 in principal per month will be forgiven for the next twelve months. The amounts forgiven are reflected as a compensation expense. In accordance with the terms of the note, as of December 31, 1999, a total of $383 in principal and accrued interest has been forgiven and the outstanding balance and accrued interest under this note on that date was $875. On December 15, 1999, Technology Solutions Company made an additional loan to Mr. Conway in the amount of $125. The note representing this loan provides for an interest rate of 5.74% and a payment date of March 1, 2000. The outstanding balance and accrued interest on this note as of December 31, 1999 was $126. Pursuant to the Distribution on February 15, 2000, eLoyalty entered into certain contractual arrangements with TSC whereby TSC will provide eLoyalty certain administrative support through June 30, 2000. NOTE 5 -- RECEIVABLES Receivables consist of the following:
AS OF DECEMBER 31, ------------------- 1999 1998 -------- -------- Amounts billed to clients................................... $39,552 $23,737 Unbilled revenues........................................... 6,588 4,344 ------- ------- 46,140 28,081 Receivable allowances....................................... (2,084) (2,638) ------- ------- $44,056 $25,443 ======= =======
Amounts billed to clients represent professional fees and reimbursable project-related expenses. Unbilled revenues represents professional fees, project-related expenses, materials and subcontractor costs which have not yet been billed. A substantial amount of unbilled revenues at the end of any reporting period is billed in the month following the reporting period. Amounts billed to clients are unsecured and primarily due within 30 days. NOTE 6 -- COMPUTERS, FURNITURE AND EQUIPMENT Computers, furniture and equipment consist of the following:
AS OF DECEMBER 31, ------------------- 1999 1998 -------- -------- Computers and software...................................... $ 3,636 $ 2,486 Furniture and equipment..................................... 1,735 756 ------- ------- 5,371 3,242 Accumulated depreciation.................................... (3,087) (1,661) ------- ------- $ 2,284 $ 1,581 ======= =======
Depreciation expense was $1,502, $421, $308 and $131 for the year ended December 31, 1999, the transition period ended December 31, 1998 and for the fiscal years ended May 31, 1998 and 1997, respectively. 39 42 eLOYALTY CORPORATION NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) NOTE 7 -- INCOME TAXES The provision for income taxes consists of the following:
FOR THE SEVEN MONTH FOR THE YEAR PERIOD FROM FOR THE YEARS ENDED JUNE 1 TO ENDED MAY 31, DECEMBER 31, DECEMBER 31, --------------- 1999 1998 1998 1997 ------------ ------------------- ------ ------ Current: Federal............................. $ 4,546 $(1,929) $ 115 $1,427 State............................... 1,059 (275) 16 204 Foreign............................. 1,876 (830) (227) (49) ------- ------- ------ ------ Total current............... 7,481 (3,034) (96) 1,582 ------- ------- ------ ------ Deferred: Federal............................. (2,008) 1,941 1,357 256 State............................... (478) 277 194 37 Foreign............................. (956) 1,214 567 22 ------- ------- ------ ------ Total deferred.............. (3,442) 3,432 2,118 315 ------- ------- ------ ------ Provision for income taxes............ $ 4,039 $ 398 $2,022 $1,897 ======= ======= ====== ======
Total income tax provision differed from the amount computed by applying the federal statutory income tax rate to income from continuing operations due to the following:
FOR THE SEVEN MONTH PERIOD FROM FOR THE YEARS FOR THE YEAR ENDED JUNE 1 TO ENDED MAY 31, DECEMBER 31, DECEMBER 31, --------------- 1999 1998 1998 1997 ------------------ ------------------- ------ ------ Federal tax provision (benefit), at statutory rate............... $2,834 $(50) $1,475 $1,688 State tax provision (benefit), net of Federal benefit.............. 405 (6) 211 241 Effect of foreign tax rate differences..................... 406 303 34 (58) Nondeductible expenses............ 134 61 96 48 Nondeductible goodwill............ 279 170 172 150 Other............................. (19) (80) 34 (172) ------ ---- ------ ------ Income tax provision.............. $4,039 $398 $2,022 $1,897 ====== ==== ====== ======
40 43 eLOYALTY CORPORATION NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) Deferred tax assets and liabilities were comprised of the following:
AS OF DECEMBER 31, ------------------ 1999 1998 -------- ------- Deferred tax assets: Deferred compensation and bonuses......................... $ 2,870 $1,794 Equity losses of unconsolidated investee.................. 341 215 Receivable allowances..................................... 918 844 Other accruals............................................ 936 743 Net operating loss carryforwards.......................... 4,996 1,803 Depreciation and amortization............................. 2,387 1,054 ------- ------ Total deferred tax assets......................... 12,448 6,453 ------- ------ Deferred tax liabilities: Prepaid expenses.......................................... (1,004) (688) ------- ------ Total deferred tax liabilities.................... (1,004) (688) ------- ------ Net deferred tax asset.................................... $11,444 $5,765 ======= ======
Net operating loss carryforwards relate primarily to eLoyalty's UK operations and have an indefinite carryforward period. Income (loss) before income taxes consisted of the following:
FOR THE SEVEN MONTH PERIOD FROM FOR THE YEARS FOR THE YEAR ENDED JUNE 1 TO ENDED MAY 31, DECEMBER 31, DECEMBER 31, ----------------- 1999 1998 1998 1997 ------------------ ------------------- ------ ------ United States......................... $7,447 $(164) $3,781 $4,527 Foreign............................... 650 19 454 296 ------ ----- ------ ------ Total....................... $8,097 $(145) $4,235 $4,823 ====== ===== ====== ======
NOTE 8 -- STOCK OPTIONS As of the Distribution, each outstanding option to purchase TSC common stock held by a person who was an employee or director of eLoyalty immediately after the Distribution (and who was not also a director of TSC) was converted into a substitute option to purchase eLoyalty common stock. The conversion of the options was done in such a manner that (1) the aggregate intrinsic value of the options immediately before and after the exchange was the same, (2) the ratio of the exercise price per option to the market value per option was not reduced, and (3) the vesting provisions and option period of the replacement options was the same as the original vesting terms and option period. The substitute option takes into account all employment with both TSC and eLoyalty for purposes of determining when the option becomes exercisable and when it terminates. All other terms of the substitute option is the same as the current TSC option. Each outstanding nonqualified TSC option granted before June 22, 1999 to a person who continued as an employee or director of TSC after the Distribution, or who was not an employee or director of either TSC or eLoyalty after the Distribution, was converted into both an adjusted TSC option and a substitute eLoyalty option. The conversion of the options was done in such a manner that (1) the aggregate intrinsic value of the options immediately before and after the exchange were the same, (2) the ratio of the exercise price per option to the market value per option was not reduced, and (3) the vesting provisions and option period of the replacement options were the same as the original vesting terms and option period. Employment with TSC 41 44 eLOYALTY CORPORATION NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) was taken into account in determining when each substitute eLoyalty option becomes exercisable and when it terminates, and in all other respects was substantially the same as the existing TSC option. Each outstanding nonqualified TSC option granted after June 21, 1999 to a person who continued as an employee or director of TSC after the Distribution, or who was not an employee or director of either TSC or eLoyalty after the Distribution, continued solely as an option to purchase shares of TSC common stock. Each TSC option that was an incentive stock option, within the meaning of Section 422 of the Code, was converted into an incentive stock option to purchase the stock of the corporation with which the optionee was employed immediately after the Distribution. These options were converted based on the relative trading prices of the stock purchasable under the option immediately after the Distribution. Immediately after the Distribution, the Company's stock traded at 83.4722 percent of the combined value of one share of the Company's stock and one share of TSC's stock. This conversion preserved both the intrinsic value of the option and the ratio of the exercise price to the fair market value of the stock. In connection with the Distribution, 6.8 million eLoyalty options were issued to replace certain TSC options as described above. In June of 1999, eLoyalty's shareholder approved the 1999 eLoyalty Stock Incentive Plan (the "Plan") for eLoyalty's directors, officers, employees and key advisors. The total number of shares of eLoyalty common stock initially reserved for issuance under the Plan is 5,340,000. Awards granted under the Plan are at the discretion of the Compensation Committee of eLoyalty's board of directors (or, prior to the Distribution, the Compensation Committee of the TSC board of directors) (the "Compensation Committee"), and may be in the form of incentive or nonqualified stock options. These options have a maximum term of 10 years. Upon adoption of the Plan, the Compensation Committee granted options to purchase 4,824,000 shares of eLoyalty's common stock at an exercise price of $3.50 per share, the deemed fair value of the underlying eLoyalty common stock to eLoyalty employees and certain employees of TSC who were instrumental to eLoyalty's operations up to and including the Distribution. The Company also issued additional options to purchase shares of eLoyalty's stock between the initial grant in June 1999 and December 31, 1999, some of which were below the deemed fair value on the date of grant, and accordingly resulted in the Company recording unearned compensation. These options have a ten-year term and 1/3 of these options vest on the second anniversary of the grant date and the remaining 2/3 vest ratably on a monthly basis over the next two years. The following table summarizes eLoyalty stock option activity during 1999:
WEIGHTED-AVERAGE SHARES EXERCISE PRICE --------- ---------------- Outstanding as of December 31, 1998......................... -- -- Granted................................................... 5,447,250 $3.88 Forfeited................................................. (107,250) $3.50 --------- ----- Outstanding as of December 31, 1999......................... 5,340,000 $3.89 ========= Stock options exercisable as of December 31, 1999........... -- =========
42 45 eLOYALTY CORPORATION NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) The following table summarizes information about eLoyalty stock options outstanding as of December 31, 1999:
OPTIONS OUTSTANDING ----------------------------------- AVERAGE WEIGHTED- REMAINING AVERAGE CONTRACTUAL EXERCISE RANGE OF EXERCISE PRICES SHARES LIFE PRICES - ------------------------ --------- ----------- --------- $ 0.01 - $ 3.50............................................. 4,901,500 10 years $ 3.50 $ 3.51 - $ 8.00............................................. 274,250 10 years $ 6.08 $ 8.01 - $12.00............................................. 118,500 10 years $10.61 $12.01 - $16.00............................................. 45,750 10 years $14.72 --------- 5,340,000 10 years $ 3.89 =========
The company elected to disclose the pro forma effects of SFAS No. 123, "Accounting for Stock Based Compensation. The fair value of eLoyalty and TSC options granted to eLoyalty employees was estimated at the grant date using the Black-Scholes option pricing model with the following weighted average assumptions:
FOR THE FOR THE SEVEN MONTH YEAR ENDED PERIOD ENDED FOR THE YEARS ENDED MAY 31, DECEMBER 31, DECEMBER 31, --------------------------------------- TSC OPTIONS 1999 1998 1998 1997 1996 - ----------- ------------ ------------ ----------- ----------- ----------- Expected volatility...... 49.7%-54.2% 43.6%-49.8% 41.9%-44.1% 40.9%-51.4% 50.6%-52.0% Risk-free interest rates.................. 4.6%-6.3% 4.1%-5.6% 5.3%-6.5% 5.3%-6.8% 5.3%-6.4% Expected lives........... 4.5 years 4.5 years 4.5 years 4.5 years 4.5 years Dividends................ 0% 0% 0% 0% 0%
ELOYALTY OPTIONS - ---------------- Expected volatility...... 50% Risk Free interest rates.................. 5.7%-6.3% Expected Lives........... 4.5 years Dividends................ 0%
The weighted average grant date fair value of options granted during the year were as follows:
FOR THE FOR THE YEARS ENDED YEAR ENDED MAY 31, DECEMBER 31, ----------------------- 1999 1999 1998 1997 ------------ ----- ----- ----- TSC Options............................................ $5.08 $8.15 $7.90 $5.24 eLoyalty Options issued at market prices............... $1.79 eLoyalty Options issued below market prices............ $8.62
For purposes of pro forma disclosures, the estimated fair value of options is amortized over the four-year average vesting period of the options. Had compensation expense related to both eLoyalty and TSC options 43 46 eLOYALTY CORPORATION NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) granted to eLoyalty employees been determined consistent with SFAS No. 123, eLoyalty's net income (loss) and net income (loss) per share would have been reduced to the pro forma amounts indicated below:
FOR THE FOR THE SEVEN MONTH FOR THE YEARS YEAR ENDED PERIOD ENDED ENDED MAY 31, DECEMBER 31, DECEMBER 31, --------------- 1999 1998 1998 1997 ------------ ------------ ------ ------ Net income(loss): As reported............................... $4,058 $ (543) $2,213 $2,926 Pro forma................................. $1,219 $(2,574) $ (500) $1,651 Basic net income(loss) per share: As reported............................... $ 0.10 $ (0.01) $ 0.05 $ 0.07 Pro forma................................. $ 0.03 $ (0.06) $(0.01) $ 0.04 Diluted net income (loss) per share: As reported............................... $ 0.09 $ (0.01) $ 0.05 $ 0.06 Pro forma................................. $ 0.03 $ (0.06) $(0.01) $ 0.04
NOTE 9 -- SEGMENT INFORMATION eLoyalty operates as a single reportable segment. The following is revenue and long-lived asset information by geographic area as of and for the year ended December 31, 1999, the seven month transition period ended December 31, 1998 and the fiscal years ended May 31, 1998 and 1997.
UNITED EUROPE AND COMBINED FOR THE YEAR ENDED DECEMBER 31, 1999 STATES CANADA AUSTRALIA TOTAL - ------------------------------------ -------- ------ ---------- -------- Revenues......................................... $113,504 $7,577 $24,922 $146,003 Identifiable Assets.............................. $ 63,770 $3,874 $28,959 $ 96,603
UNITED EUROPE AND COMBINED FOR THE SEVEN MONTH PERIOD FROM JUNE 1 TO DECEMBER 31, 1998 STATES CANADA AUSTRALIA TOTAL - ----------------------------------------------------------- -------- ------ ---------- -------- Revenues.............................................. $ 50,139 $3,729 $10,547 $ 64,415 Identifiable Assets................................... $ 42,715 $3,300 $17,889 $ 63,904
UNITED COMBINED FOR THE YEAR ENDED MAY 31, 1998 STATES CANADA EUROPE TOTAL - ------------------------------- -------- ------ ---------- -------- Revenues......................................... $ 61,882 $6,296 $16,310 $ 84,488 Identifiable Assets.............................. $ 34,711 $3,008 $16,399 $ 54,118
UNITED COMBINED FOR THE YEAR ENDED MAY 31, 1997 STATES CANADA EUROPE TOTAL - ------------------------------- -------- ------ ---------- -------- Revenues......................................... $ 30,346 $1,963 $10,872 $ 43,181 Identifiable Assets.............................. $ 11,068 $2,598 $10,522 $ 24,188
44 47 eLOYALTY CORPORATION NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) NOTE 10 -- LEASES eLoyalty leases various office facilities under operating leases expiring at various dates through July 31, 2004. Additionally, eLoyalty leases various property and office equipment under operating leases expiring at various dates. Rental expense for all operating leases approximated $1,436, $469, $738 and $133 for the year ended December 31, 1999, the transition period ended December 31, 1998 and for the fiscal years ended May 31, 1998 and 1997, respectively. Future minimum rental commitments under noncancelable operating leases with terms in excess of one year are as follows:
CALENDAR YEAR AMOUNT - ------------- ------ 2000........................................................ $1,018 2001........................................................ 791 2002........................................................ 614 2003........................................................ 441 2004........................................................ 415 Thereafter.................................................. 70 ------ $3,349 ======
NOTE 11 -- COMMITMENTS AND CONTINGENCIES The Company is involved in various pending or threatened claims in the normal course of business. Management believes that losses, if any, arising from such claims will not have a material adverse affect on the Company's financial position, results of operations or cash flows. NOTE 12 -- CAPITAL STOCK In 1999, eLoyalty was established as a wholly-owned subsidiary of TSC. In connection with establishing eLoyalty as a separate legal entity, 100,000,000 shares of common stock, $.01 par value, were authorized, of which a total of 41,400,000 common stock shares were issued to TSC. The Company also has authorized 10,000,000 shares of preferred stocks, $.01 par value, of which none has been issued. 45 48 eLOYALTY CORPORATION NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) NOTE 13 -- QUARTERLY DATA (UNAUDITED)
1ST 2ND 3RD 4TH YEAR IN THOUSANDS, EXCEPT PER SHARE DATA --- --- --- --- ---- FOR THE YEAR ENDED DECEMBER 31, 1999 Revenues....................................... $31,491 $36,145 $40,016 $38,351 $146,003 Gross Profit................................... $18,215 $18,296 $20,555 $18,525 $ 73,591 Net income (loss).............................. $ 727 $ 1,480 $ 1,879 $ (28) $ 4,058 Basic net income (loss) per share.............. $ 0.02 $ 0.04 $ 0.05 $ (0.01) $ 0.10 Diluted net income (loss) per share............ $ 0.02 $ 0.03 $ 0.04 $ (0.01) $ 0.09 Shares used to calculate basic net income (loss) per share (in millions)............... 41.4 41.4 41.4 41.4 41.4 Shares used to calculate diluted net income (loss) per share (in millions)............... 42.4 42.4 44.6 41.4 44.2 FOR THE YEAR ENDED DECEMBER 31, 1998 Revenues....................................... $23,643 $25,998 $28,044 $27,550 $105,235 Gross Profit................................... $11,933 $13,855 $14,433 $14,327 $ 54,548 Net income (loss).............................. $ 828 $ 894 $ 292 $ (947) $ 1,067 Basic net income (loss) per share.............. $ 0.02 $ 0.02 $ 0.01 $ (0.02) $ 0.03 Diluted net income (loss) per share............ $ 0.02 $ 0.02 $ 0.01 $ (0.02) $ 0.02 Shares used to calculate basic net income (loss) per share (in millions)............... 41.4 41.4 41.4 41.4 41.4 Shares used to calculate diluted net income (loss) per share (in millions)............... 43.1 43.2 43.1 41.4 43.1
NOTE 14 -- SUBSEQUENT EVENTS Effective February 15, 2000 TSC completed its spin-off its eLoyalty division into a separate publicly traded company. In connection with the spin-off, TSC contributed to eLoyalty an additional $20 million of cash. In addition, in connection with the spin-off, eLoyalty entered into a $10 million revolving line of credit facility with Bank of America to provide cash for short term operating obligations. Pursuant to the Reorganization Agreement and certain other agreements relating to the spin off, Technology Solutions Company has agreed to guarantee obligations under this facility through December 31, 2000. The borrowing under this revolving credit facility bear interest at a rate of LIBOR plus .75%. The credit facility contains customary representations, warranties, covenants and default provisions, including working capital commitments and debt to equity ratios. On June 22, 1999, certain venture capital investors agreed to purchase an aggregate of 2.4 million shares of eLoyalty Common Stock at $3.50 per share, subject to adjustment pursuant to certain anti-dilution provisions. Stock purchase was subject to the receipt of a private letter ruling from the Internal Revenue Service to the effect that the Distribution would be tax free to TSC and its stockholders for United States Federal Income tax purposes and certain other customary connections. On January 27, 2000, TSC received a favorable ruling from the Internal Revenue Service that the spin-off of its eLoyalty division would be a tax free distribution of all of the Company's eLoyalty shares to TSC's shareholders. In connection with the Distribution, on February 15, 2000, the venture capital investors purchased 2.5 million eLoyalty Common Stock shares for $8.4 million, reflecting adjustments pursuant to certain anti-dilution provisions. On January 26, 2000, the Board of Directors adopted a Stockholder Rights Plan (the "Rights Plan"). The Rights Plan is intended to assure fair and equal treatment for all of the Company's stockholders in the event of a hostile takeover attempt. Under the terms of the Rights Plan, each share of the Company's 46 49 eLOYALTY CORPORATION NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) Common Stock has associated with it one Right. Each Right entitles the registered holder to purchase from the Company one one-hundredth of a share of Series A Junior Participating Preferred Stock, par value $.01 per share, at an exercise price of $160.00 (subject to adjustment). The Rights become exercisable under certain circumstances following the announcement that any person has acquired 15 percent or more of the Company's Common Stock or the announcement that any person has commenced a tender offer for 15 percent or more of the Company's Common Stock. The Company may redeem the Rights in whole, but not in part, at a price of $.01 per Right at any time until ten days after any person has acquired 15 percent or more of the Company's Common Stock. 47 50 ELOYALTY CORPORATION SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS FOR THE YEAR ENDED DECEMBER 31, 1999, THE SEVEN MONTH PERIOD ENDED DECEMBER 31, 1998 AND FOR THE YEARS ENDED MAY 31, 1999 AND 1997 (IN THOUSANDS)
BALANCE AT BALANCE AT DESCRIPTION OF BEGINNING END OF ALLOWANCE AND RESERVES OF YEAR ADDITIONS DEDUCTIONS YEAR ---------------------- ---------- --------- ---------- ---------- May 31, 1997 Valuation allowances and receivable reserves for potential losses................................... $ 184 $ 453 $ (439) $ 198 May 31, 1997 Valuation allowances and receivable reserves for potential losses................................... $ 198 $ 531 $ (254) $ 475 December 31, 1998 Valuation allowances and receivable reserves for potential losses................................... $ 475 $2,652 $ (489) $2,638 December 31, 1999 Valuation allowances and receivable reserves for potential losses................................... $2,638 $2,059 $(2,613) $2,084
48 51 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ELOYALTY'S MANAGEMENT DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES Set forth below is information concerning the executive officers, other key employees and members of our board of directors upon completion of the spin-off. The ages listed below are as of December 31, 1999.
NAME AGE POSITION ---- --- -------- Kelly D. Conway............................ 43 Director, President and Chief Executive Officer Tench Coxe................................. 41 Director and Chairman of the Board of Directors Jay C. Hoag................................ 41 Director John T. Kohler............................. 53 Director Michael J. Murray.......................... 55 Director John R. Purcell............................ 68 Director Michael R. Zucchini........................ 53 Director Timothy J. Cunningham...................... 46 Senior Vice President and Chief Financial Officer Craig B. Lashmet........................... 39 Senior Vice President -- North American Operations Arthur J. Bird............................. 46 Senior Vice President -- European Operations Chris J. Danson............................ 32 Senior Vice President -- Development and Support Julie M, Fitzpatrick....................... 32 Senior Vice President -- Marketing Jackie L. Hilt............................. 43 Senior Vice President -- Employee Loyalty Kevin J. Kraft............................. 34 Senior Vice President -- Solutions Marketing Stephen D. Mayers.......................... 42 Senior Vice President -- Australian Operations Michael Weintraub.......................... 40 Senior Vice President -- Operations
KELLY D. CONWAY has been our President and Chief Executive Officer and a Director of eLoyalty since our incorporation in May 1999. Mr. Conway joined Technology Solutions Company in November 1993 as Senior Vice President, assumed the position of Executive Vice President in July 1995 and became Group President of Technology Solutions Company in October 1998. Prior to joining Technology Solutions Company, he was a partner in the management consulting firm of Spencer, Shenk and Capers from 1991 to 1993. From 1989 to 1991, he was President and Chief Executive Officer of Telcom Technologies, a leading manufacturer of automatic call distribution equipment. From 1984 to 1989, he held the positions of Vice President of Finance and Vice President of Marketing for Telcom Technologies. From 1980 to 1984, he was a consultant with Deloitte, Haskins and Sells. In 1998, he became a board member of Edify Corporation. TENCH COXE is our Chairman of the board of directors. Mr. Coxe has served as a managing director of the general partner of Sutter Hill Ventures, a venture capital company located in Palo Alto, California, since 1989. From 1984 to 1987, Mr. Coxe served as Director of Marketing and in other management positions with Digital Communications Associates. Mr. Coxe is currently on the Board of Directors of Clarus Corporation, Copper Mountain Networks, Inc., NVidia Corporation, Alteon WebSystems, Inc. and various private companies. JAY C. HOAG has been, since June 1995, a general partner of Technology Crossover Ventures, a venture capital group located in Palo Alto, California. From 1985 to 1994, he was a managing director with Chancellor 49 52 Capital Management, Inc. Mr. Hoag serves on the board of directors of Onyx Software Corporation, Autoweb.com, Inc., iVillage, Inc. and several privately held companies. JOHN T. KOHLER has been a Director of eLoyalty since May 1999. Mr. Kohler is currently Technology Solutions Company's President and Chief Executive Officer and has been a Director of Technology Solutions Company since June 1994. He joined Technology Solutions Company as Senior Vice President in June 1992, was promoted to Executive Vice President and named to the Office of the Chairman in September 1993, became President and Chief Operating Officer in January 1994 and became Chief Executive Officer in June 1995. From 1986 to 1992, he was Senior Vice President and Chief Information Officer of Kimberly-Clark Corporation. From 1983 to 1986, he was a partner and regional practice director for the Midwest Region consulting practice of Arthur Young. He is also currently serving as a Director of Follett Corporation and Infosis Corp. MICHAEL J. MURRAY has been a Director of eLoyalty since June 1999 and a Director of Technology Solutions Company since July 1988. Mr. Murray is President of Global Corporate and Investment Banking at Bank of America Corporation and a member of their Policy Committee. Reporting to Mr. Muffayare the Global Capital Raising and Global Markets, International Corporate Banking Group, United States & Canada Group and Principal Investing. From March 1997 until the BankAmerica-NationsBank merger in 1998, Mr. Murray headed BankAmerica Corporation's Global Wholesale Bank and was responsible for its business with large corporate, international and government clients around the world. Mr. Murray was named a BankAmerica vice chairman and head of the United States and International Groups in September 1995. He had been responsible for BankAmerica's United States Corporate Group since BankAmerica's merger with Continental Bank Corporation in September 1994. Prior to the BankAmerica-Continental Bank merger, he was vice chairman and head of Corporate Banking for Continental Bank, which he joined in 1969. He is also currently serving as a Director of CNF Transportation Inc., a transportation company located in Palo Alto, California. JOHN R. PURCELL has been a Director of eLoyalty since June 1999 and a Director of Technology Solutions Company since July 1988. He has served as Chairman and Chief Executive Officer of Grenadier Associates, Ltd., a venture banking, merger and acquisition consulting firm, since 1989. From February 1991 until 1997, he served as Chairman of Donnelley Marketing, Inc., a direct marketing company. From 1987 until 1990, he served as Chairman of Mindscape, Inc., an educational entertainment computer software company. From 1982 until 1986, he served as Chairman and President of SFN Companies, Inc., a communications company. He previously served as Executive Vice President of CBS, Inc. and Senior Vice President, Finance of Gannett Co., Inc. He is also currently serving as a Director of Bausch & Lomb, Inc., Omnicom Group Inc. and Journal Register Company. MICHAEL R. ZUCCHINI has been a Director of the Company since October 1997. Until his retirement in December 1999, he had served as Vice Chairman of Fleet Boston Financial, a financial services company, since 1993 and as its Chief Technology Officer since April 1997. Mr. Zucchini joined Fleet Boston Financial in 1987 from General Re Corp., where he had been a senior executive since 1974. From 1997 until 1999, he served as Chairman of the Financial Services Roundtable Subcommittee on Legislation and Registration charged with interactivity with Congress on issues related technology. He is also currently serving as a Director of Technology Solutions Company, served from 1993 to 1999 as a Director of Visa, U.S.A. Inc., and served from 1995 to 1996 as a Director of American Re Corporation. TIMOTHY J. CUNNINGHAM has been eLoyalty's Senior Vice President and Chief Financial Officer since November 15, 1999. From October 1998 until November 1999 he held the position of Vice President -- Finance and Chief Financial Officer of CTS Corporation, a publicly traded electronics and communications company. Prior to joining CTS, Mr. Cunningham served as Vice President -- Finance of the Moore Document Solutions division of Moore Corporation from July 1996 to September 1998, and from 1995 to 1996, he was the Group Controller for the ConAgra Refrigerated Foods group of ConAgra, Inc. Prior to that, Mr. Cunningham served as Chief Financial Officer -- North America for British Steel Inc., a U.S. based subsidiary of a large European industrial products company, where he was employed from 1989 to 1994. 50 53 CRAIG B. LASHMET is the Senior Vice President of eLoyalty with overall responsibility for Sales and Delivery in North America, which represents our largest revenue base. Mr. Lashmet first joined Technology Solutions Company in October 1995 as Senior Vice President. Prior to joining Technology Solutions Company he was a partner with Grant Thornton LLP, an international accounting and consulting firm, where he managed the advanced technology consulting practice for nine years. ARTHUR J. BIRD is eLoyalty's Senior Vice President responsible for Sales and Delivery in Europe. Mr. Bird joined Technology Solutions Company in October 1997 as a Senior Vice President initially responsible for Sales and Delivery in the United Kingdom and, beginning in November 1998, all of Europe. Mr. Bird previously worked for CSC Computer Sciences, where he was European Director at the JP Morgan Pinnacle Alliance in London from June 1995 to October 1997. Prior to working for CSC, Mr. Bird spent two years with Energis plc, a wholly-owned subsidiary of The National Group, where he held positions as Director of Customer Service and Director of Corporate Sales. CHRIS J. DANSON leads eLoyalty's Development and Support as Senior Vice President, and his responsibilities include managing the Loyalty Lab in Austin, Texas and our Loyalty Support offering. Mr. Danson first joined Technology Solutions Company in 1993 as a senior consultant, and became a Senior Vice President in September, 1998. He managed several large projects and helped develop our European operations. JULIE M. FITZPATRICK is Senior Vice President of Marketing for eLoyalty. Ms. Fitzpatrick joined Technology Solutions Company in 1996 as a principal, after a seven-year career at IBM Corporation. While at IBM, she held several positions, including account systems engineer, product marketing manager and product manager for strategic call center and middleware technologies. JACKIE L. HILT is our Senior Vice President responsible for employee Loyalty, which includes recruiting and human resources functions with a specific emphasis on employee relationships. Ms. Hilt has been with Technology Solutions Company for ten years, most recently as the Senior Vice President of Technology Solutions Company's international recruiting organization, a role she assumed in 1994. Prior to joining Technology Solutions Company, she was part of Ernst & Young's Midwest Consulting Practice. KEVIN J. KRAFT is a Senior Vice President of eLoyalty responsible for Solutions Marketing. Mr. Kraft joined Technology Solutions Company in 1995 as a Senior Principal, became a Vice President in 1996, and assumed the role of Senior Vice President, Solutions Marketing in December 1997. Prior to joining Technology Solutions Company, Mr. Kraft was a senior manager in Grant Thornton LLP's advanced technology consulting practice. STEPHEN D. MAYERS is eLoyalty's Senior Vice President responsible for Sales and Delivery in Australia. Mr. Mayers joined Technology Solutions Company's ECM division in July 1998. Previously he worked for two years with the Colonial Limited Group, a large Australian-based financial services group, as General Manager -- Strategic Development for its retail financial services business through both its insurance and banking divisions. From 1994 to 1996, Mr. Mayers was Assistant General Manager for Commonwealth Bank of Australia responsible for marketing and product development in the retail banking sector. MICHAEL WEINTRAUB is a Senior Vice President of eLoyalty responsible for Operations since June 1998. Mr. Weintraub joined Technology Solutions Company in October 1997 as a Vice President in charge of The Bentley Group acquisition. From September 1993 to September 1997, Mr. Weintraub was Vice President & General Manager of The MEDSTAT Group, a health care strategy business offering consulting, applications technology, and information services. Messrs. Kohler, Murray and Purcell resigned from the Technology Solutions Company board of directors at the time of the spin-off. BOARD COMMITTEES The Company intends to create an audit committee and a compensation committee in the near future. The audit committee will review the internal accounting procedures of eLoyalty and consult with and review 51 54 the services provided by eLoyalty's independent accountants. The audit committee is expected to include Messrs. Murray and Hoag. The compensation committee will review and recommend to the board the compensation and benefits of all executive officers of eLoyalty, administer eLoyalty's stock-based incentive plans and establish and review general policies relating to compensation and benefits of employees of eLoyalty. The compensation committee is expected to consist of Messrs. Purcell and Coxe. 52 55 ITEM 11. EXECUTIVE COMPENSATION The following table sets forth compensation information paid by the Company for our Chief Executive Officer and the four other executive officers. All information set forth in this table reflects compensation earned by these individuals for services with eLoyalty and its subsidiaries. The people listed in the table below are sometimes referred to as Named Executive Officers. SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION ------------------- SECURITIES FISCAL UNDERLYING ALL OTHER NAME AND PRINCIPAL POSITION YEAR SALARY BONUS OPTIONS COMPENSATION - --------------------------- ------ -------- -------- ---------- ------------ Kelly D. Conway........................ 1999 $480,000 $266,573 625,000(3) $387,303(6) President and 1998(1) 266,667 120,000 65,000 2,800(6) Chief Executive Officer 1998(2) 440,000 100,000 135,000 2,000(6) Craig B. Lashmet....................... 1999 $400,000 $211,448 350,000(3) 4,167(7) Senior Vice President, 1998(1) 226,667 90,000 97,750(4) 2,431(7) North America 1998(2) 340,000 95,000 33,750(5) 1,737(7) Arthur J. Bird......................... 1999 $314,300 $ 61,620 100,000(3) $ 23,569(8) Senior Vice President 1998(1) 176,400 57,038 19,189 17,070(8) European Operations 1998(2) 156,683 29,066 0 17,540(8) Kevin Kraft............................ 1999 $260,000 $127,005 100,000(3) $ 18,586(9) Senior Vice President 1998(1) 151,667 57,000 17,100 7,374(9) Solutions Marketing 1998(2) 231,667 62,773 0 19,100(9) Chris Danson........................... 1999 $260,000 $129,438 100,000(3) $ 16,133(10) Senior Vice President 1998(1) 145,000 57,000 36,838 2,800(10) Development & Support 1998(2) 200,000 50,000 0 2,000(10)
- --------------- (1) The compensation figures reported cover the transition period from June 1, 1998 through December 31, 1998. (2) The compensation figures reported cover the fiscal year ended May 31, 1998. (3) Subject to option provisions regarding termination of employment, one third of these options become exercisable on July 1, 2001 and 1/36 of these options become exercisable on the last day of each calendar month for 24 months. (4) 47,750 of the 97,750 options reported for the transition period ended December 31, 1998 were granted pursuant to a stock option repricing program offered by Technology Solutions Company to all of its employees other than its executive officers. (5) The 33,750 options reported for the fiscal year ended May 31, 1998 were surrendered pursuant to the stock option repricing program described in footnote 4. (6) The other compensation consisted of principal and interest forgiven under a Promissory Note dated November 12, 1998. It also includes employer 401K contributions of $4,800, $2,000, and $2,800 in 1999, year ended 1998, and fiscal year ended 1998, respectively. (7) The other compensation consists of 401K employer contributions. (8) The other compensation consisted of principal and interest forgiven under a Promissory Note dated November 4, 1997. (9) The other compensation consisted of principal and interest forgiven under a Promissory Note dated September 4, 1998. It also includes employer 401K contributions of $4,800, $2,000, and $2,800 in 1999, year ended 1998, and fiscal year ended 1998, respectively. (10) The other compensation consisted of principal and interest forgiven under a Promissory Note dated September 13, 1999. It also includes employer 401K contributions of $4,800, $2,000, and $2,800 in 1999, year ended 1998, and fiscal year ended 1998, respectively. 53 56 OPTION GRANTS IN LAST FISCAL YEAR The following tables show all grants of options to acquire shares of eLoyalty common stock granted to the Named Executive Officers in the year ended December 31, 1999. In connection with the spin-off, each nonqualified option to purchase Technology Solutions Company common stock held by an employee or director of eLoyalty (1) who will not also be a director of Technology Solutions Company, will be converted into a substitute option to purchase eLoyalty common stock, and (2) who will also be a director of Technology Solutions Company, will be converted into a substitute option to purchase eLoyalty common stock and an adjusted Technology Solutions Company option. In addition, each incentive stock option, within the meaning of section 422 of the Code, held by an employee of eLoyalty will be converted into an option to purchase shares of eLoyalty common stock. See "eLoyalty's Relationship with Technology Solutions Company After the Spin-Off -- Technology Solutions Company Stock Options" for a more complete discussion of the treatment of options to purchase Technology Solutions Company common stock in connection with the spin-off. OPTION GRANTS IN THE YEAR ENDED DECEMBER 31, 1999
INDIVIDUAL GRANTS(1) ---------------------------------------------------- PERCENT OF NUMBER TOTAL POTENTIAL REALIZED VALUE OF OPTIONS AT ASSUMED ANNUAL RATES OF SECURITIES GRANTED TO STOCK PRICE APPRECIATION UNDERLYING EMPLOYEES EXERCISE OR FOR OPTION TERM OPTIONS IN FISCAL BASE PRICE EXPIRATION --------------------------- NAME GRANTED YEAR (PER SHARE) DATE 5%(3) 10%(3) - ---- ---------- ---------- ----------- ---------- ------------ ------------ Kelly D. Conway................. 625,000(2) 12% 3.50 7/1/09 $1,375,707 $3,486,312 Craig B. Lashmet................ 350,000(2) 7% 3.50 7/1/09 770,396 1,952,335 Arthur J. Bird.................. 100,000(2) 2% 3.50 7/1/09 220,113 557,810 Kevin Kraft..................... 100,000(2) 2% 3.50 7/1/09 220,113 557,810 Chris Danson.................... 100,000(2) 2% 3.50 7/1/09 220,113 557,810
- --------------- (1) Upon a sale of substantially all of the business and assets of the company, the board may accelerate the exercise date of these options. (2) Subject to option provisions regarding termination of employment, one third of these options become exercisable on July 1, 2001 and 1/36 of these options become exercisable on the last day of each calendar month for 24 months. (3) Amounts reflect assumed rates of appreciation set forth in the SEC's executive compensation disclosure rules. Actual gains, if any, on stock option exercises depend on future performance of our common stock and overall stock market conditions. No assurance can be given that the amounts reflected in these columns will be achieved. EXERCISES OF STOCK OPTIONS AND FISCAL YEAR END OPTION VALUES The following table shows aggregate exercises of options to purchase Technology Solutions Company and eLoyalty common stock in the year ended December 31, 1999 by the Named Executive Officers and other information concerning the options to purchase Technology Solutions Company and eLoyalty common stock held by each of them at the end of such period. In connection with the spin-off, each nonqualified option to purchase Technology Solutions Company common stock held by an employee or director of eLoyalty (1) who will not also be a director of Technology Solutions Company, will be converted into a substitute option to purchase eLoyalty common stock, and (2) who will also be a director of Technology Solutions Company, will be converted into a substitute option to purchase eLoyalty common stock and an adjusted Technology Solutions Company option. In addition, each incentive stock option, within the meaning of section 422 of the Code, held by an employee of eLoyalty will be converted into an option to purchase shares of eLoyalty common stock. 54 57 AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUE
NUMBER OF SECURITIES UNDERLYING UNEXERCISED VALUE OF UNEXERCISED SHARES OPTIONS AT IN-THE-MONEY OPTIONS ACQUIRED DECEMBER 31, 1999 AT DECEMBER 31, 1999 ON VALUE --------------------------- --------------------------- NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE ---- -------- -------- ----------- ------------- ----------- ------------- Kelly D. Conway Technology Solutions Company Options......... -- -- 481,849 54,980 $11,348,742 $ 760,603 eLoyalty Options........ -- -- -- 625,000 -- $12,143,750 Craig B. Lashmet Technology Solutions Company Options......... -- -- 120,346 58,407 $ 2,938,809 $ 1,360,497 eLoyalty Options........ -- -- -- 350,000 -- $ 6,800,500 Arthur J. Bird Technology Solution Options................. -- -- 8,783 23,689 $ 195,520 $ 298,522 eLoyalty Options........ -- -- -- 100,000 -- $ 2,868,750 Kevin Kraft Technology Solution Options................. -- -- 1,602 15,498 $ 35,183 $ 4,445,598 eLoyalty Options........ -- -- -- 100,000 -- $ 2,868,750 Chris Danson Technology Solution Options................. -- -- 34,355 51,000 $ 865,748 $ 477,503 eLoyalty Options........ -- -- -- 100,000 -- $ 2,868,750
INCENTIVE PLANS 1999 STOCK INCENTIVE PLAN Officers, directors, key employees, consultants, independent contractors and agents of eLoyalty and its subsidiaries are eligible to participate in the 1999 Stock Incentive Plan. The 1999 Stock Incentive Plan provides for the grant of non-statutory stock option awards, incentive stock option awards, stock appreciation rights awards, restricted stock awards, bonus stock awards and performance share awards. An aggregate of 5,340,000 shares of eLoyalty common stock will be initially reserved for issuance under the 1999 Stock Incentive Plan for all awards other than any awards issued in connection with the spin-off in substitution of previously granted options to purchase shares of Technology Solutions Company common stock. The aggregate number of shares of eLoyalty common stock available for issuance under the 1999 Stock Incentive Plan will be increased as of the first day of each fiscal year of eLoyalty beginning on or after January 1, 2000, by an amount equal to 5% of the total number of shares of eLoyalty common stock then outstanding. Subject to adjustments set forth in the 1999 Stock Incentive Plan, the maximum number of shares of eLoyalty common stock that may be granted to any person during (1) the 1999 fiscal year is 750,000 and (2) any other fiscal year of eLoyalty is 300,000. The 1999 Stock Incentive Plan also provides that each non-employee director will receive an option to purchase 25,000 shares of common stock when he or she commences service as a director. Each current non-employee director (other than a non-employee director who received an option grant on July 1, 1999) received such an option. In addition, on the day following the date of each annual stockholders' meeting beginning with the stockholders' meeting to be held in 2000, each non-employee director (other than a non-employee director who receives an initial grant at that meeting) will receive an option to purchase 6,000 shares of eLoyalty common stock. If the non-employee director received an initial grant since the previous annual meeting, the annual grant will be reduced proportionately. The stock options granted to non-employee directors will (1) have an exercise price per share equal to the fair market value of a share of eLoyalty common stock on the grant date, (2) expire ten years after the grant date and (3) become exercisable in 48 equal monthly installments, commencing with the last day of the calendar month following the calendar month in which the option is granted. 55 58 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth, as of the close of business on March 24, 2000, certain information with respect to the beneficial ownership of Common Stock beneficially owned by (i) each director of the Company, (ii) the most highly compensated executive officers of the Company (collectively, the "named officers"), (iii) all executive officers and directors as a group and (iv) each stockholder who is known to the Company to be the beneficial owner, as defined in Rule 13d-3 under the Securities Exchange Act of 1934, as amended
SHARES OF COMMON PERCENTAGE OF NAME AND ADDRESS OF BENEFICIAL OWNER STOCK OWNED OUTSTANDING SHARES ------------------------------------ ---------------- --------------------- Massachusetts Financial Services Company(1)............... 3,337,960 7.1% FMR Corp.(2).............................................. 2,272,950 4.8% GeoCapital LLC(3)......................................... 2,864,139 6.1% Brookside Capital Partners Fund, L.P.(4).................. 3,355,300 7.1%
Kelly D. Conway........................................... 562,462(5) 1.2% Tench Coxe................................................ 1,548,740(6) 3.2% Jay C. Hoag............................................... 1,698,740(7) 3.5% John T. Kohler............................................ 455,212(8) 1.0% Michael J. Murray......................................... 292,089(9) * John R. Purcell........................................... 732,403(10) 1.5% Michael R. Zucchini....................................... 42,427(11) * Timothy J. Cunningham..................................... 0 * Craig B. Lashmet.......................................... 163,105(12) * Arthur J. Bird............................................ 12,437(13) * Chris J. Danson........................................... 54,350(14) * Kevin J. Kraft............................................ 7,329(15) * --------- ----- All Directors and Executive Officers as a group (12 5,569,294(16) 11.5% persons)................................................
- --------------- * Less than one percent (1) Based on the most recent report on Schedule 13G/A filed with the SEC on February 11, 2000, Massachusetts Financial Services Company is expected to have sole voting power with respect to 3,337,960 shares of Technology Solutions Company common stock and sole dispositive power with respect to 3,337,960 shares of Technology Solutions Company common stock. Massachusetts Financial Services Company is located at 500 Boylston Street, Boston, MA 02116. (2) Based on the most recent joint report on Schedule 13G, filed with the SEC on February 16, 1999, FMR is expected to have sole voting power with respect to 2,272,950 shares of Technology Solutions Company common stock to be converted to eLoyalty Common Stock. FMR Corp.'s address is 82 Devonshire Street, Boston, MA 02109. (3) Based on the most recent report on Schedule 13G, filed with the SEC on February 8, 2000, GeoCapital LLC is expected to have sole dispositive power with respect to 2,864,139 shares of Technology Solutions Company common stock. GeoCapital's address is 767 Fifth Ave. 45th Fl., New York, NY 10153-4590. (4) Based on the most recent report on Schedule 13G, filed with the SEC on February 11, 2000, Brookside Capital Partners Fund, L.P. is expected to have sole voting power with respect to 3,355,300 shares of Technology Solutions Company common stock and sole dispositive power with respect to 3,355,300 shares of Technology Solutions Company common stock. Brookside's address is Two Copely Place, Boston, Massachusetts 02116. (5) Includes 543,953 shares Mr. Conway has the right to acquire under options which are currently exercisable or which will be exercisable within 60 days. (6) Includes 1,548,740 shares beneficially owned by Sutter Hill Ventures, a venture capital company. Mr. Coxe serves as a managing director of the general partner of Sutter Hill Ventures and, by virtue of such position, has shared voting power with respect to shares owned by Sutter Hill Ventures. Mr. Coxe disclaims beneficial ownership of the shares held by Sutter Hill Ventures except to the extent of his interest in the partnership. (7) Includes shares beneficially owned by the following four entities controlled by Technology Crossover Management III, L.L.C. ("TCM III"): TCV III (GP), TCV III, L.P., TCV III (Q), L.P. and TCV III Strategic Partners, L.P. (the "Funds"). Mr. Hoag serves as a managing member of Technology Crossover Management III, L.L.C., and by virtue of such position has, together with one other managing member, sole investment control with respect to TCM III and, therefore, the Funds. Mr. Hoag disclaims beneficial ownership of the shares held by TCM III and the Funds except to the extent that he has pecuniary interest in such shares by virtue of his interest in TCM III. 56 59 (8) Includes 355,157 shares Mr. Kohler has the right to acquire under options which are currently exercisable or which will be exercisable within 60 days. Mr. Kohler has indicated that he may sell up to 552,500 shares of common stock of Technology Solutions Company after January 1, 2000 and prior to the spin-off. The share amounts do not reflect that possible sale. (9) Includes 117,253 shares Mr. Murray has the right to acquire under options which are currently exercisable or which will be exercisable within 60 days. (10) Includes 20,216 shares Mr. Purcell has the right to acquire under options which are currently exercisable or which will be exercisable within 60 days. Includes 33,437 shares held by Mr. Purcell's wife and 93,750 shares held by the Purcell Foundation. (11) Includes 34,875 shares Mr. Zucchini has the right to acquire under options which are currently exercisable or which will be exercisable within 60 days. Includes 1,687 shares held by Mr. Zucchini's wife. (12) Includes 160,435 shares Mr. Lashmet has the right to acquire under options which are currently exercisable or which will be exercisable within 60 days. (13) Includes 12,437 shares Mr. Bird has the right to acquire under options which are currently exercisable or which will be exercisable within 60 days. (14) Includes 44,226 Mr. Danson has the right to acquire under options which are currently exercisable or which will be exercisable within 60 days. (15) Includes 4,797 Mr. Kraft has the right to acquire under options which are currently exercisable or which will be exercisable within 60 days. (16) Includes 1,293,350 shares of common stock issuable under options which are currently exercisable or which will be exercisable within 60 days. All directors and officers are located at 205 N. Michigan Ave., Suite 1500, Chicago, IL 60601. 57 60 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS We have entered into a common stock purchase and sale agreement with Sutter Hill Ventures and Technology Crossover Ventures. On June 22, 1999, these investors agreed to purchase an aggregate of 2,400,000 shares of our common stock at $3.50 per share. The price was determined by the board of directors of Technology Solutions Company to be the fair value of the eLoyalty common stock on June 22, 1999. The purchase and sale of common stock to the investors was exempt from registration under Section 4(2) of the Securities Act because the transactions did not involve a public offering. On November 12, 1998, Technology Solutions Company made a loan of $1,200,000 to Mr. Conway with a five-year term that, to the extent not forgiven in whole or in part as described below, is payable on demand upon the cessation of Mr. Conway's employment with Technology Solutions Company or its affiliates. The loan bears interest at the rate of 4.5% per annum and, so long as Mr. Conway remains employed by us or our affiliates, the note provides that the principal amount of the loan (and interest accrued thereon) is to be forgiven over a five-year period as follows: 25% of the principal amount on November 12, 1999; $25,000 in principal per month for the next twelve months; $20,000 in principal per month for the next twenty-four months; and $10,000 in principal per month for the next twelve months. In accordance with the terms of the note, as of December 31, 1999, a total of $382,503 in principal and accrued interest has been forgiven, and Mr. Conway's outstanding balance and accrued interest under this note on that date was $875,299. On December 15, 1999, Technology Solutions Company made an additional loan to Mr. Conway in the amount of $125,000. The note representing this loan provides for an interest rate of 5.74% and a payment date of March 1, 2000. The notes representing these loans have been assigned to eLoyalty in connection with the separation of our business operations from Technology Solutions Company. 58 61 eLOYALTY'S RELATIONSHIP WITH TECHNOLOGY SOLUTIONS COMPANY AFTER THE SPIN-OFF The spin-off, and the transactions being undertaken in connection with the spin-off, are being effected according to a Reorganization Agreement between us and Technology Solutions Company. In addition, we have entered into or will enter into ancillary agreements contemplated by the Reorganization Agreement and other agreements that will govern various ongoing relationships between us and Technology Solutions Company. Below is a summary description of the Reorganization Agreement and some of the ancillary agreements. This description, which summarizes the material terms of those agreements, does not purport to be complete and is qualified in its entirety by reference to the full text of the agreements. Some of these agreements, including the Reorganization Agreement and the forms of Shared Services Agreement and Tax Sharing and Disaffiliation Agreement, have been filed with the Securities and Exchange Commission as exhibits to our registration statement on Form S-1 (No. 333-94293). REORGANIZATION AGREEMENT The Reorganization Agreement provides for, among other things, the principal corporate transactions required to effect the separation of our business from the remaining Technology Solutions Company business, the spin-off and other agreements governing the relationship between us and Technology Solutions Company after the spin-off. Pursuant to the Reorganization Agreement, Technology Solutions Company has transferred to us substantially all of the assets, and we have assumed substantially all of the corresponding liabilities, of our business. The assets of eLoyalty's business were transferred to us on an "as is, where is" basis and no representations or warranties will be made by Technology Solutions Company regarding those assets. Subject to some exceptions, the Reorganization Agreement provides for cross-indemnities principally designed to place financial responsibility for the liabilities of our business with us and financial responsibility for the obligations and liabilities of Technology Solutions Company's retained business with Technology Solutions Company. Specifically, we have agreed to assume liability for, and to indemnify Technology Solutions Company against, any and all liabilities associated with our business. These liabilities include any litigation, proceedings or claims relating to the products, services and operations thereof whether or not the underlying basis for such litigation, proceeding or claim arose prior to or after the date of the transfer of our business by Technology Solutions Company to us. Technology Solutions Company has agreed to indemnify us against any and all liabilities associated with Technology Solutions Company's retained business. The Reorganization Agreement provides for the allocation of benefits between Technology Solutions Company and us under existing insurance policies after the date of the spin-off for claims made or occurrences prior to the date of the spin-off and sets forth procedures for the administration of insured claims. In addition, the Reorganization Agreement provides that Technology Solutions Company will use its reasonable efforts to maintain directors' and officers' insurance at substantially the level of Technology Solutions Company's current directors' and officers' insurance policy for a period of three years with respect to the directors and officers of Technology Solutions Company who are directors and officers of eLoyalty as of the date of the spin-off for acts relating to periods prior to the date of the spin-off. The Reorganization Agreement also provides that Technology Solutions Company and eLoyalty are granted access to some records and information in the possession of the other. This requires the retention by Technology Solutions Company and us, for a period of seven years following the spin-off, of the information in its possession relating to the other. Further, the party in possession of the information must use commercially reasonable efforts to notify the other party of its intention to dispose of such information and, with respect to tax information, the period shall be extended to one year after the expiration of the applicable statute of limitations. The Reorganization Agreement also provides that for 18 months starting December 1, 1999, neither Technology Solutions Company nor eLoyalty can solicit or recruit any of the employees of the other. Further, 59 62 the Reorganization Agreement will address the treatment of employee benefit matters and other compensation arrangements for some former and current eLoyalty employees and their beneficiaries and dependents. These provisions of the Reorganization Agreement contemplate that we will establish retirement savings and welfare plans. The Reorganization Agreement provides that the account balances (including outstanding loans) of all eLoyalty employees participating in Technology Solutions Company's deferred compensation and 401(k) plans are transferred to eLoyalty's new deferred compensation and 401(k) plans and assets held in trust related to such account balances are transferred to new trusts established by us. The Reorganization Agreement will also generally provide that, after the spin-off, we will assume all liabilities for benefits under any welfare plans related to our employees, other than specified claims incurred on or before the spin-off. Moreover, the Reorganization Agreement provides that, effective as of the spin-off, we are responsible for all other liabilities to our employees. The Reorganization Agreement also provides that eLoyalty maintain an employee stock purchase plan substantially similar to Technology Solutions Company's 1995 employee stock purchase plan. TAX SHARING AND DISAFFILIATION AGREEMENT The Technology Solutions Company and eLoyalty Tax Sharing and Disaffiliation Agreement sets forth the rights and obligations of Technology Solutions Company and eLoyalty with respect to taxes imposed on their respective businesses both before and after the spin-off and with respect to "Restructuring Taxes." General Taxes. Under the Tax Sharing and Disaffiliation Agreement, we will be liable for and indemnify Technology Solutions Company against any taxes (other than Restructuring Taxes) that are attributable to the business carried on by us. We will indemnify Technology Solutions Company against these taxes even though they may have been incurred prior to the formation of eLoyalty. Technology Solutions Company will indemnify us against any taxes (other than Restructuring Taxes) that are attributable to the business retained by Technology Solutions Company. The Tax Sharing and Disaffiliation Agreement sets forth rules for determining taxes attributable to the eLoyalty business and taxes attributable to the business retained by Technology Solutions Company. Restructuring Taxes. Under the Tax Sharing and Disaffiliation Agreement, we will, in general, be liable for any Restructuring Taxes imposed by reason of any "eLoyalty Tainting Act," which means: - any inaccuracy or breach of specified representations, warranties, or covenants in the IRS ruling and the material submitted to the IRS in connection with that ruling, in each case, describing the eLoyalty Group (generally, our affiliates and us) or the eLoyalty business; - any action (or failure to take any reasonably available action) by any member of the eLoyalty Group; or - any acquisition or other transaction involving the capital stock of eLoyalty (other than the distribution of the capital stock of eLoyalty in the spin-off). Under the Tax Sharing and Disaffiliation Agreement, Technology Solutions Company will, in general, be liable for any Restructuring Taxes imposed by reason of any "Technology Solutions Company Tainting Act," which means: - any inaccuracy or breach of specified representations, warranties, or covenants in the IRS ruling and the materials submitted to the IRS in connection with that ruling, in each case, describing the Technology Solutions Company Group (generally, Technology Solutions Company and its affiliates) or the business retained by Technology Solutions Company; - any action (or failure to take any reasonably available action) by any member of the Technology Solutions Company Group; or - any acquisition or other transaction involving the capital stock of Technology Solutions Company (other than the distribution of the capital stock of eLoyalty in the spin-off). Under the Tax Sharing and Disaffiliation Agreement, eLoyalty and Technology Solutions Company are each liable for 50% of Restructuring Taxes that are not imposed as a result of either an eLoyalty Tainting Act or a Technology Solutions Company Tainting Act. If a Restructuring Tax is imposed where there is both an eLoyalty Tainting Act and a Technology Solutions Company Tainting Act, and each of the eLoyalty Tainting 60 63 Act and the Technology Solutions Company Tainting Act would alone be sufficient to result in the imposition of such Restructuring Tax, eLoyalty and Technology Solutions Company are each liable for 50% of such Restructuring Tax. Finally, in the case of a Restructuring Tax that would not have been imposed but for the existence of both an eLoyalty Tainting Act and a Technology Solutions Company Tainting Act, eLoyalty and Technology Solutions Company are each liable for such Restructuring Tax to the extent the eLoyalty Tainting Act and the Technology Solutions Company Tainting Act, respectively, contributed to the imposition of such Restructuring Tax. Option Deductions. Under the Tax Sharing and Disaffiliation Agreement, Technology Solutions Company will generally be liable to eLoyalty for an amount equal to (A) any actual federal income tax reduction realized by Technology Solutions Company as a result of a "Net Option Deduction," which term, in general, means any federal income tax deduction or loss (to the extent in excess of any income or gain) recognized by the Technology Solutions Company Affiliated Group (generally, Technology Solutions Company and its subsidiaries that file on a consolidated basis) upon the exercise of eLoyalty stock options by employees of any member of such group minus (B) any employment (or similar) taxes borne by any member of the Technology Solutions Company Affiliated Group with respect to such taxable year as a result of the exercise of eLoyalty stock options by employees of any member of the Technology Solutions Company Affiliated Group. This liability arises only with respect to eLoyalty options exercised after the date eLoyalty provides Technology Solutions Company with an opinion of tax counsel concluding that a Net Option Deduction is available to the Technology Solutions Company Affiliated Group. Technology Solutions Company may condition its liability with respect to a taxable year upon confirmation from tax counsel that no change in law or other circumstance has rendered the original tax opinion's conclusion incorrect. We will be liable to Technology Solutions Company for losses or expenses attributable to the reduction, elimination or deferral of a Net Option Deduction for which Technology Solutions Company has previously made payment to us. Administrative matters. The Tax Sharing and Disaffiliation Agreement will also set forth the obligations of eLoyalty and Technology Solutions Company with respect to the filing of tax returns, the administration of tax contests and other matters. SHARED SERVICES AGREEMENT Technology Solutions Company and eLoyalty have entered into a Shared Services Agreement, pursuant to which Technology Solutions Company provides to eLoyalty administrative services that may be necessary to eLoyalty's business. Technology Solutions Company will provide eLoyalty with, among other things, accounting, tax, benefits administration, human resources, information systems, insurance and legal services. The Shared Services Agreement will expire on June 30, 2000 unless the parties mutually agree upon a renewal. For benefits administration, human resources and information systems services Technology Solutions Company will charge eLoyalty based on its percentage of the total number of Technology Solutions Company and eLoyalty employees. For accounting, tax and insurance services Technology Solutions Company will charge eLoyalty based on its percentage of the total revenues of Technology Solutions Company and eLoyalty. TECHNOLOGY SOLUTIONS COMPANY INTELLECTUAL PROPERTY LICENSE AGREEMENT Technology Solutions Company and eLoyalty entered into a Technology Solutions Company Intellectual Property Agreement, pursuant to which Technology Solutions Company will grant to eLoyalty a nonexclusive, royalty-free, worldwide, perpetual license in and to intellectual properties, processes, know-how and technical information of Technology Solutions Company which are not used primarily in connection with eLoyalty's business but which are used in connection with eLoyalty's business as of the date of the spin-off. eLOYALTY INTELLECTUAL PROPERTY LICENSE AGREEMENT eLoyalty and Technology Solutions Company entered into an eLoyalty Intellectual Property Agreement, pursuant to which eLoyalty will grant to Technology Solutions Company a nonexclusive, royalty-free, worldwide, perpetual license in and to intellectual properties, processes, know-how and technical information which were assigned to eLoyalty, which are used primarily in connection with eLoyalty's business, and which were also used in connection with Technology Solutions Company's businesses other than eLoyalty's business as of the date of the spin-off. 61 64 ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)(1) Financial Statements The following combined financial statements and supplemental schedule of eLoyalty and Report of Independent Accountants thereon are included herein:
PAGE ---- FINANCIAL STATEMENTS Report of Independent Accountants........................... 29 Combined Balance Sheets as of December 31, 1999 and 1998.... 30 Combined Statements of Operations for the years ended December 31, 1999 and 1998 (unaudited), the seven month period from June 1, 1998 to December 31, 1998, and for each of the two years in the period ended May 31, 1998.... 31 Combined Statements of Cash Flows for the years ended December 31, 1999 and 1998 (unaudited), the seven month period from June 1, 1998 to December 31, 1998, and for each of the two years in the period ended May 31, 1998.... 32 Combined Statements of Changes in Stockholder's Equity and Comprehensive Income (Loss) for the year ended December 31, 1999, the seven month period ended December 31, 1998, and for each of the two years in the period ended May 31, 1998...................................................... 33 Notes to Combined Financial Statements...................... 34
FINANCIAL STATEMENT SCHEDULE Schedule II -- Valuation and Qualifying Accounts........................... 48
(a)(2) Financial Statement Schedules Included in Item 14(a)(1) above All other schedules to the financial statements required by Article 7 of Regulation S-X are not required under the related instructions or are inapplicable and therefore have been omitted. (a)(3) Listing of Exhibits The Exhibits required to be part of this Annual Report are listed in the Index to Exhibits on Page 63. (b) Reports on Form 8-K None (c) Exhibits Included in Item 14(a)(3) above. 62 65 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Chicago, State of Illinois, on March 30, 2000. eLOYALTY CORPORATION By: /s/ KELLY D. CONWAY ---------------------------------- Kelly D. Conway President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report on Form 10-K has been signed by the following persons on behalf of eLoyalty Corporation and in the capacities and on the dates indicated:
SIGNATURE TITLE(S) DATE --------- -------- ---- /s/ KELLY D. CONWAY Director, President and March 30, 2000 - ----------------------------------------------------- Chief Executive Officer Kelly D. Conway (principal executive officer) /s/ TIMOTHY J. CUNNINGHAM Chief Financial Officer March 30, 2000 - ----------------------------------------------------- (principal financial officer Timothy J. Cunningham and principal accounting officer) /s/ JOHN T. KOHLER Director March 30, 2000 - ----------------------------------------------------- John T. Kohler /s/ MICHAEL J. MURRAY Director March 30, 2000 - ----------------------------------------------------- Michael J. Murray /s/ JOHN R. PURCELL Director March 30, 2000 - ----------------------------------------------------- John R. Purcell /s/ TENCH COXE Director March 30, 2000 - ----------------------------------------------------- Tench Coxe /s/ MICHAEL R. ZUCCHINI Director March 30, 2000 - ----------------------------------------------------- Michael R. Zucchini /s/ JAY C. HOAG Director March 30, 2000 - ----------------------------------------------------- Jay C. Hoag
63 66 INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION - ----------- ----------- 2.1+ Form of Reorganization Agreement between TSC and eLoyalty 3.1+ Certificate of Incorporation of eLoyalty, as amended 3.2+ Bylaws of eLoyalty 4.1+ Form of Rights Agreement between eLoyalty and ChaseMellon Shareholder Services, L.L.C. as Rights Agent 10.1+ 1999 Stock Incentive Plan and Amendment Number One 10.2+ 1999 Employee Stock Purchase Plan 10.3+ Common Stock Purchase and Sale Agreement dated August 13, 1999 among TSC, eLoyalty, Sutter Hill Ventures, TCV III (GP), TCV III, L.P., TCV III (Q), L.P. and TCV III Strategic Partners, L.P. 10.4+ Registration Rights Agreement dated August 13, 1999 among TSC, Sutter Hill Ventures, TCV III (GP), TCV III, L.P., TCV III (Q), L.P. and TCV III Strategic Partners, L.P. 10.5+ Form of Shared Services Agreement between TSC and eLoyalty 10.6+ Form of Tax Sharing and Disaffiliation Agreement between TSC and eLoyalty 10.7+ Form of TSC (Licensor) Intellectual Property License Agreement 10.8+ Form of eLoyalty (Licensor) Intellectual Property License Agreement 10.9+ Employment Agreement of Kelly D. Conway 10.10+ Employment Agreement of Timothy J. Cunningham 10.11+ Employment Agreement of Craig Lashmet 10.12+ Kelly D. Conway Promissory Note dated November 12, 1998 10.13+ Office Lease -- Two Conway Park made as of December 6, 1999 by and between Riggs & Company as Landlord and eLoyalty as Tenant 10.14+ eLoyalty Corporation Executive Deferred Compensation Plan dated January 1, 2000 10.15 Office Lease -- River Place Point II made as of March 17 by and between Investors Life Insurance and eLoyalty as Tenant 10.16 Line of Credit -- Bank of America 21.1 Subsidiaries of eLoyalty 23.1 Consent of PricewaterhouseCoopers LLP, Chicago, Illinois, Independent Accountants 27 Financial Data Schedule
- --------------- + Incorporated by reference to the Company's Registration Statement on Form S-1 (No 333-94293) which was made effective by the Securities and Exchange Commission on February 8, 2000. 64 EX-10.15 2 OFFICE LEASE 1 EXHIBIT 10.15 RIVER PLACE POINTE II LEASE AGREEMENT By and Between INVESTORS LIFE INSURANCE COMPANY OF NORTH AMERICA ("Landlord") and ELOYALTY CORPORATION ("Tenant") DATED: MARCH ____, 2000 2 RIVER PLACE POINTE II LEASE AGREEMENT THIS LEASE is entered into as of March ____, 2000, between INVESTORS LIFE INSURANCE COMPANY OF NORTH AMERICA, a Washington corporation ("Landlord"), whose address for purposes of notice hereunder is 701 Brazos, Suite 1400, Austin, Texas, 78701 and eLOYALTY CORPORATION, a Delaware corporation ("Tenant"), whose local address prior to the Commencement Date (defined in Section 2.01 hereof) is 701 Brazos, Suite 680, Austin, Texas 78701, and whose local address after the Commencement Date shall be 6500 River Place Boulevard, Building II, Suite 400, Austin, Texas, 78730. W I T N E S S E T H: ARTICLE 1 1.01 PREMISES. Landlord hereby leases to Tenant, and Tenant hereby leases from Landlord, for the rent and subject to the provisions of this Lease, the space (the "Premises") reflected on the floor plan(s) attached as Exhibit "A" hereto, consisting of the entire fourth (4th) floor and approximately the east one-half (2) of the third (3rd) floor of the building (the "Building") known as River Place Pointe II located at 6500 River Place Boulevard, Austin, Travis County, Texas, in River Place Pointe (the "Project"). The Project is a multi-building office project under construction by Landlord containing multiple office buildings, ground-level open areas and walkways, parking areas and garages and other structures or improvement located on the real property described on Exhibit "B" attached hereto and made a part hereof for all purposes (the "Land"). The Building, as well as River Place Pointe I and the River Place Pointe Parking Garage I ("Parking Garage I") are currently under construction by Landlord. It is anticipated that the Premises will contain approximately 40,691 square feet of rentable area and the Building will contain approximately 112,782 net rentable square feet as measured by the most recent BOMA Standard Method of Floor Measurement (the "BOMA Standard(s)"). The usable and rentable square footage of the Premises shall be measured by Landlord's architect, and such measurement shall be approved by Tenant's architect, in accordance with BOMA Standards, taking into account that the fourth floor will be a single tenant floor and the third floor will be a multi-tenant floor. In the event the measurement of the Premises according to BOMA Standards results in a change in the rentable area of the Premises, all appropriate terms herein shall be adjusted accordingly. Within ten (10) days after the Commencement Date Tenant and Landlord shall execute a declaration (in the form of Exhibit "D" hereto) specifying, among other things, the measurements of the Premises and the Building as determined by Landlord's architect and approved by Tenant's architect. ARTICLE 2 3 2.01 TERM. Subject to the other provisions hereof, and any exhibits hereto, this Lease shall be for a term of approximately five (5) years commencing on the Commencement Date (defined in Section 2.02 hereof) and expiring on May 31, 2005 (the "Expiration Date"). Such term, as it may be modified or extended, is herein called the "Term." A "Lease Year" shall be the twelve month period beginning on June 1 of each calendar year and ending on May 31 of the following calendar year. 2.02 COMMENCEMENT. As used herein, "Commencement Date" means the earlier to occur of: (a) June 7, 2000, or if later, the date the Premises (including the Tenant Improvements described on Exhibit "C") are Substantially Completed (as hereinafter defined), or would have been Substantially Completed but for Tenant Delays (as defined in Exhibit "C"), and Landlord has notified Tenant of such completion, or (b) the date Tenant begins the occupancy of all or any part of the Premises in a reasonably normal manner for the conduct of Tenant's business. The parties anticipate the Premises will be Substantially Complete on or about June 7, 2000. "Substantial Completion" (or "Substantially Complete" or "Substantially Completed") shall mean that Landlord has received a temporary or permanent certificate of occupancy from the City of Austin permitting Tenant's occupancy of the Premises, that Tenant's architect has approved the measurement of the Premises as taken my Landlord's architect, and that the Premises (and parking and other improvements in the Project reasonably necessary to Tenant's use and enjoyment of the Premises) are sufficiently complete to allow Tenant's use and occupancy of the Premises, except for any work upon which Landlord and Tenant shall have agreed to in writing ("Punch List Items"), the performance of which shall not, after Tenant commences occupancy of the Premises, significantly interrupt or interfere with Tenant's use thereof. Landlord agrees to complete any Punch List Items within thirty (30) days after the Commencement Date. Within ten (10) days after the Commencement Date Tenant and Landlord shall execute a declaration (in the form of Exhibit "D" hereto) specifying, among other things, the actual date on which the Commencement Date occurred. Landlord hereby consents to Tenant having limited access to the Premises three (3) weeks prior to the Commencement Date (the "Early Access Period") to install its equipment and furnishings preparatory to its occupancy of the Premises, subject however to City of Austin temporary certificate of occupancy requirements and City of Austin Fire Department and Building Inspection Department life safety issues ("COA Issues"), and provided Tenant has delivered to Landlord evidence of all insurance required to be carried by Tenant under this Lease. Tenant's early access to the Premises is governed by Paragraph 10 of the Exhibit "C" hereto. Landlord and Tenant agree to mutually and reasonably cooperate with each other during the Early Access Period. Tenant acknowledges and agrees that during the Early Access Period, Landlord may still be in process of completing the Tenant Improvements, including, without limitation, laying carpet. During the Early Access Period, Tenant will use reasonable efforts to accommodate Landlord's completion of the Tenant Improvements. Likewise, Landlord 2 4 acknowledges and agrees that during the Early Access Period, Tenant will be installing, subject to COA Issues, wiring, equipment and furniture (including wall and furniture systems) and Landlord will use reasonable efforts to accommodate Tenant's pre-occupancy installations during the Early Access Period. Landlord acknowledges that Tenant is not required to pay rent during the Early Access Period. 2.03 RENEWAL OPTION. Landlord hereby gives and grants to Tenant two (2) options to renew this Lease for respective periods of five (5) years each, on the terms and conditions set forth in Exhibit "E". The first renewal term shall commence on the expiration of the initial Term, and the second renewal term shall commence on the expiration of the Term as extended by the first renewal option. 2.04 RIGHT OF FIRST REFUSAL. Landlord hereby grants Tenant a right of first refusal with respect to all remaining space on the third floor of the Building as set forth in "Exhibit "F". 2.05 EXPANSION OPTION. Landlord hereby gives and grants to Tenant an expansion option ("Expansion Option") on the terms and conditions set forth in Exhibit "G". ARTICLE 3 3.01 BASE RENT. Tenant, in consideration for this Lease, agrees to pay to Landlord a base rental ("Base Rent") for each square foot of rentable area agreed to in writing by Landlord and Tenant to be within the Premises, for each calendar year during this Lease as follows: Lease Year 1 - $18.50 per rentable square foot Lease Year 2 - $19.00 per rentable square foot Lease Year 3 - $19.50 per rentable square foot Lease Year 4 - $20.00 per rentable square foot Lease Year 5 - $20.50 per rentable square foot The Base Rent shall be payable in equal monthly installments, the amount of which shall be determined by dividing the total rent for each respective Lease Year by twelve (12), and payable at Landlord's address herein provided in legal tender of the United States of America, without notice, demand, counterclaim, set-off or abatement (except as expressly provided in this Lease), in advance on the first day of each calendar month throughout the Term, except that the first such monthly installment is due upon the date of execution of this Lease by Tenant. Notwithstanding the foregoing, if the Commencement Date is a date other than the first day of a calendar month, then the rent for the Base Rent for the first month of this Lease shall be a sum equal to the Base Rent specified for the first full calendar month as herein provided, times a fraction, the numerator of which equals the number of days from the Commencement Date to the end of the 3 5 calendar month during which the Commencement Date falls and the denominator of which equals the number of days in the same calendar month. 3.02 TENANT'S PERCENTAGE SHARE OF OPERATING EXPENSES. In addition to the Base Rent, Tenant, as additional consideration for this Lease, agrees to pay to Landlord Tenant's Percentage Share of Operating Expenses (defined in Section 3.04 hereof) annualized for each calendar year during the Term. On or before the Commencement Date and thereafter on or before the first day of each calendar year of the Term, Landlord shall provide to Tenant the Estimated Operating Expense (defined in Section 3.03 hereof) for the upcoming calendar year. Tenant shall pay in advance on the first day of each calendar month during the Term, installments equal to one-twelfth (1/12) of Tenant's Percentage Share of Estimated Operating Expenses annualized for each calendar year. Within one hundred twenty (120) days after the end of each calendar year during the Term, Landlord shall furnish to Tenant a statement certified by Landlord of the Actual Operating Expenses for the immediately preceding calendar year. If Tenant's Percentage Share of Estimated Operating Expenses paid to Landlord during the previous calendar year exceeds Tenant's Percentage Share of Actual Operating Expenses for such year, then Landlord shall refund the difference to Tenant at the time Landlord furnishes the statement of the Actual Operating Expense. Otherwise, within fifteen (15) days after Landlord furnishes such statement to Tenant, Tenant shall make a lump sum payment to Landlord equal to the positive difference between Tenant's Percentage Share of the Actual Operating Expense for the preceding calendar year over Tenant's Percentage Share of the Estimated Operating Expense paid by Tenant for the preceding calendar year. As used in this Lease the term "Rent" shall refer collectively to the Base Rent and Tenant's Percentage Share of Estimated Operating Expenses. If the Commencement Date is on a day other than the first day of the month, then Tenant shall be required to pay only a pro-rata portion of the installment of Rent due for such month. Landlord will cause adequate books and records to be maintained to permit Tenant to verify computations of Operating Expenses and other amounts relevant to Tenants obligations under this Lease; provided, Landlord shall not be required to maintain any books and records concerning any payment due hereunder for more than 2 years after such payment is due. Further, Landlord shall permit Tenant or Tenant's representative to audit such books and records during normal business hours and shall assist in any way reasonably required for such audits. Landlord shall also furnish explanations in reasonable detail if requested by Tenant of any computation made under this Lease. All determinations required or permitted of Landlord concerning payments for Operating Expenses and other charges due hereunder shall be subject to verification by Tenant. If any such determinations are found to be incorrect, an adjustment will be promptly made between Landlord and Tenant to correct any underpayments or overpayments resulting from such incorrect determinations. If an audit of Operating Expenses for any calendar year reveals that Tenant was overcharged under this Section 3.02 by more than ten percent (10%) for that year, Landlord will reimburse Tenant for the cost of such audit. However, notwithstanding that a disagreement may arise between Tenant and Landlord about any 4 6 determination required or permitted of Landlord concerning Rent and other charges due hereunder, Tenant shall continue to pay Rent and other charges as herein provided pending resolution of such determination. 3.03 TENANT'S PERCENTAGE SHARE. For purposes of this Lease, the term "Tenant's Percentage Share" shall mean a percentage which is equal to the number of rentable square feet contained in the Premises divided by the total number of rentable square feet contained in the Building, as both such measurements have been agreed to in writing by Landlord and Tenant. 3.04 OPERATING EXPENSES. "Operating Expenses" shall mean and include all reasonable amounts, expenses, and costs of whatever nature paid by or on behalf of Landlord for the management (excluding wages and benefits for employees above the level of building manager), operation, repair, maintenance and security of the Building and Landlord's personal property which may be reasonably utilized in connection therewith. Without limiting the foregoing, Operating Expenses will include a share (equal to the rentable square footage of the Building divided by the total rentable square footage of all buildings in the Project from time to time) of any costs and expenses incurred by Landlord which are for the benefit of the Project generally, rather than any particular Building. If, however, greater security is required for an occupant of a particular building in the Project, or if an occupant requires repairs or maintenance to such occupant's specific tenant improvements (excluding however, repairs or maintenance to the Base Building which are included in Operating Expenses), the cost of such greater security or repairs or maintenance to such occupant's specific tenant improvements will not be treated as a cost for the benefit of the Project generally under this provision, but will be allocated specifically to such occupant. Notwithstanding the foregoing, controllable Operating Expenses (which include landscaping, janitorial, pest control and waste removal) shall not increase more than five percent (5%) per annum. Notwithstanding anything to the contrary herein, Operating Expenses shall not include, and Tenant shall not be required to pay or reimburse Landlord for any part of the following: property management fees in excess of five percent (5%) of Base Rent; the cost of capital improvements or depreciation (except as expressly permitted by the next sentence); interest and principal payments on mortgages, ground lease rentals and other non-operating debts of Landlord; specific costs for special items or services billed to specific tenants (or that would be billed to another tenant if its lease required payments in addition to base rent on substantially the same terms and conditions as this Lease requires of Tenant); costs of correcting construction or design defects or violations of law existing as of the Commencement Date; legal fees or other costs incurred because of any lease negotiation or dispute between Landlord and other tenants or prospective tenants; income, excess profits, franchise, transfer, estate or inheritance taxes; costs paid by insurance, recovery upon construction warranties or other sources (excluding reimbursement by tenants for Operating Expenses); leasing commissions, attorneys' fees, 5 7 advertising expenses, and other expenses incurred in connection with leasing, selling or conveying any interest in the Project or the land associated therewith; costs of repairs or other work occasioned by fire, wind storm or other casualty or necessitated by condemnation. Operating Expenses shall, however, include: (A) The annual cost of all capital improvements made subsequent to the final completion of the Building (including the Premises) which, although capital in nature, can reduce the normal operating costs of the Building, as amortized in accordance with generally accepted accounting principles, consistently applied; provided that such amortization shall not be more in any calendar year than Landlord's reasonable estimate of the resulting savings in other Operating Expenses. (B) The annual cost of all capital improvements made in order to comply with any statutes, rules, regulations, or directives enacted or promulgated by any governmental authority after the effective date of this Lease, as amortized in accordance with generally accepted accounting principles, consistently applied. If at any time during the Term the present method of ad valorem taxation or assessment against the Land, Building or Project shall be so changed that the whole or any part of the real estate taxes or assessments now levied, assessed or imposed on the Land, Building or Project shall be changed and as a substitute therefor, or in lieu of an addition thereto, taxes, assessments or charges shall be levied, assessed or imposed wholly or partially as a capital levy or otherwise on the rents received from the Project or the Rent due under this Lease or any part thereof, then such substitute or additional taxes, assessments or charges, to the extent so levied, assessed or imposed, shall be deemed to be included within the real estate taxes to the extent that such substitute or additional tax actually substitutes for and replaces prior real estate taxes or is imposed in lieu of or in addition to existing real estate taxes. Operating Expenses shall be determined on an accrual basis in accordance with generally accepted accounting principles, consistently applied. The "Estimated Operating Expense" shall equal the Landlord's reasonable estimate of Operating Expenses for the applicable calendar year. Landlord's statement of the Estimated Operating Expense shall control for the year specified in such statement and for each succeeding year during the Term until Landlord provides a new statement of the Estimated Operating Expense. Landlord's Estimated Operating Expense for the calendar year 2000 is $8.00 per rentable square foot, prorated for the number of months in 2000 the Building is completed. The "Actual Operating Expense" shall equal the operating expenses actually incurred for the applicable calendar year. Notwithstanding the foregoing, in no event shall Tenant be required to pay an amount in excess of the total of Actual Operating Expenses less amounts payable by other tenants in the Building. 6 8 Operating Expenses shall be reduced by any insurance proceeds or eminent domain awards to the extent the same may be received by Landlord. Landlord may deduct from such proceeds or awards, the reasonable expenses incurred in obtaining such proceeds or awards (including without limitation legal and other professional fees) provided that such expenses were not previously billed as Estimated Operating Expenses or Actual Operating Expenses. 3.05 TENANT IMPROVEMENTS. Prior to the applicable Commencement Date, Landlord shall, on the terms and conditions set forth in Exhibit "C" construct the improvements desired by Tenant to complete the Premises for Tenant's occupancy (the "Tenant Improvements"). ARTICLE 4 4.01 USE. Tenant shall use and occupy the Premises only for office purposes, for software development and training, and for no other purposes. Tenant shall not do or permit anything to be done in the Premises or authorize anything to be done in other parts of the Project, nor shall Tenant bring or keep anything in the Project, that will in any way increase the existing rate of or affect any fire or other insurance upon the Project or any of its contents, or cause cancellation of any insurance policy covering the Project or any part thereof or any of its contents. Tenant shall not do or permit anything to be done in the Premises or authorize anything to be done in other parts of the Project that will unreasonably or improperly obstruct or interfere with the rights of other tenants or occupants of the Project or injure or annoy them or tend to lower the first class character of the building or create unreasonable elevator loads or otherwise interfere with standard Building operations. Tenant shall not do or permit anything to be done in the Premises or authorize anything to be done in other parts of the Project that would constitute a nuisance. Tenant shall not commit or suffer to be committed any waste in or upon the Premises. Tenant shall not use the Premises nor authorize or permit anything to be done in other parts of the Project that will in any way conflict with any private restrictive covenant, law, statute, ordinance or any rule or regulation of Landlord or any governmental or quasi-governmental authority now in force or that may hereafter be enacted or promulgated. ARTICLE 5 5.01 LANDLORD'S SERVICES. Provided Tenant is not in default hereunder, Landlord shall, at Landlord's expense, except as provided to the contrary in this Lease, furnish to Tenant the following services: (a) Subject to curtailment as required by governmental laws, rules or regulations, air conditioning and central heat, in season, at temperatures between 67 and 78 degrees F., during all Normal Building Hours. ("Normal Building Hours" will be 7:00 a.m. through 6:00 p.m. on weekdays and 8:00 a.m. through 12:00 p.m. on 7 9 Saturdays, exclusive of Normal Business Holidays. "Normal Business Holidays" for purposes of this Lease shall be the days reasonably designated as such by Landlord from time to time (but not more than nine days in any calendar year), which days may include, without limitation, New Year's Day, Martin Luther King Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day, the Friday following Thanksgiving Day and Christmas Day. If in the case of any holiday described herein a different day shall be observed than the respective day described, then the day which constitutes the day observed by national banks in Austin, Texas, on account of such holiday shall constitute the holiday under this Lease.) (b) Janitorial services in the Premises and public portions of the Building for all days except Saturdays, Sundays, and Normal Business Holidays. (c) Water at those points of supply provided for drinking, toilet, and lavatory purposes. (d) Normal and customary routine maintenance, and any repairs required from time to time, for all public, structural, and exterior portions of the Project and for the HVAC and other Building systems. (e) Electric lighting service for all public portions of the Building, Parking Garage I, the surface parking areas serving the Building, and the Project. (f) Reasonably adequate, non-exclusive automatic passenger elevator service at all times for access to and egress from the Premises. There are no separate freight elevators in the Building. Tenant shall have the right to use the passenger elevators, in common with other tenants, for freight uses during reasonable business hours as prescribed by Landlord, exclusive of Saturdays, Sundays, and Normal Business Holidays unless otherwise approved by Landlord, as long as Tenant appropriately pads the elevator walls to insure that no damage is caused to elevators by virtue of Tenant's use for freight purposes. If Tenant desires to use any elevator for freight purposes for any extended period (more than one hour), Tenant must get the prior approval of Landlord. (g) Electric energy that Tenant shall require for normal office equipment such as typewriters, dictation machines, calculators, personal computers, telephones, facsimile machines, copying machines and other machines of a similar electrical consumption, and Building Standard (defined in Exhibit "C" attached hereto) lighting in the Premises. Without Landlord's prior written consent, Tenant shall not be entitled to employ lighting on the Premises that consumes electrical current 8 10 in excess of Building Standard lighting nor utilize space heaters nor utilize any office equipment that consumes more than 0.5 kilowatts per hour at rated capacity or requires a voltage of other than 120 volts single phase or an electric capacity greater than any limitations on capacity contemplated in the Drawings approved by Landlord and Tenant as described in Exhibit "C". The Building will have normal and customary electrical service typical to supply a first class office building in Austin, Texas, for use by all of the tenants of the Building. (h) Building security to encourage compliance with the Rules and Regulations (defined in Section 15.09 hereof) and to limit after-hour access to the Building; provided, however, Landlord shall have no responsibility to prevent, and shall not be liable to Tenant for, and shall be indemnified by Tenant against, liability or loss to Tenant, its agents, employees and visitors arising out of losses due to theft, burglary, or damage or injury to persons or property caused by persons having or gaining access to the Building or the Premises, whether or not caused by Landlord's negligence, and Tenant hereby releases Landlord from all liability relating thereto. Tenant shall have 24-hour access to the Building and the Premises by a card access system (i) Window washing services for the outside portions of the Building up to two (2) times per calendar year, as needed. 5.02 ADDITIONAL SERVICE COST. Tenant shall pay Landlord, upon demand, such additional amounts as are necessary to recover additional costs incurred by Landlord in performing or providing janitorial, maintenance, security, or other services or requirements of Tenant (and in paying additional taxes) as to any non-Building Standard installations in the Premises. Tenant shall pay Landlord, upon monthly demand by invoice, an amount equal to one hundred ten percent (110%) of Landlord's actual or reasonably estimated cost for providing off-hour and nonstandard air conditioning, heating and electricity service to the Premises. Such after hours service will be available by card access or key pad. 5.03 SERVICE INTERRUPTION. To the extent any of the services described above require electricity, gas, water or other services supplied by public utilities, Landlord's covenants hereunder shall impose on Landlord only the obligation to use its good faith efforts to cause the applicable public utilities to furnish the same. Any failure or defect in the services described above shall not be construed as an eviction of Tenant nor entitle Tenant to any reduction, abatement, offset, or refund of Rent or to any damages from Landlord. Landlord shall not be in breach or default under this Lease, provided Landlord uses reasonable diligence during normal business hours to restore any such failure or defect after Landlord receives written notice thereof. 9 11 ARTICLE 6 6.01 ALTERATIONS. Tenant shall not make or allow to be made any alterations, installations, additions or improvements in or to the Premises, or place safes, vaults or other heavy furniture or equipment within the Premises, without Landlord's prior written consent. Such consent by Landlord will not be unreasonably withheld or delayed for interior, nonstructural alterations to the Premises that do not require modifications to the Building HVAC or other systems. All alterations, installations, additions or improvements, other than movable furniture, wall systems, equipment, and trade fixtures, made by Tenant to the Premises shall remain upon and be surrendered with the Premises and become the property of Landlord at the expiration or termination of this Lease or the termination of Tenant's right to possession of the Premises; provided, however, that Landlord may require Tenant, at Tenant's cost, to remove any or all of such items made by Tenant that are not Building Standard upon the expiration or termination of this Lease or the termination of Tenant's right to possession of the Premises. Tenant, at its sole cost and prior to the expiration or termination of this Lease, shall remove all of Tenant's property from the Premises and make, or reimburse Landlord for the cost of all repairs to the Premises and/or Project for damage resulting from such removal. Tenant is not required, however, to remove any Initial Tenant Improvements or any subsequent alterations approved by Landlord. All work shall be completed promptly and in a good and workmanlike manner and shall be performed in such a manner that no mechanic's, materialman's or other similar liens shall attach to Tenant's leasehold estate, and in no event shall Tenant permit, or be authorized to permit, any such liens or other claims to be asserted against Landlord or Landlord's rights, estate and interests with respect to the Project or this Lease. If the cost of any alterations, installations, additions or improvements to the Premises exceeds $5,000.00, Landlord may require, at Tenant's sole cost and expense, a lien and completion bond in an amount equal to the estimated cost of such improvements, additions or alterations Tenant proposes to make in the Premises. 6.02 TENANT REPAIRS. By taking possession of the Premises, Tenant shall be deemed to have accepted the Premises as being in good, sanitary order, condition and repair, subject to Punch List Items and latent defects. Tenant shall, at Tenant's sole cost and expense, keep the Premises in good condition and repair, excepting damage thereto by fire or other casualty or resulting from causes beyond the reasonable control of Tenant and further excepting ordinary wear and tear. Other than as herein provided to the contrary with respect to damages resulting from fire or other insurable casualties, any injury or damage to the Premises or Project, or the appurtenances or fixtures thereof, caused by or resulting from the negligent acts or omissions of or the intentional misconduct of Tenant or Tenant's employees, servants, agents, invitees, assignees, or subtenants shall be repaired or replaced by Tenant, or at Landlord's option by Landlord, at the expense of Tenant. If Tenant fails to maintain the Premises or fails to repair or replace any damage to the Premises or Project resulting from the negligence or intentional act of Tenant, its employees, servants, agents or invitees, or for which Tenant is otherwise 10 12 responsible by the terms of this Lease, Landlord may, but shall not be obligated to, cause such maintenance, repair or replacement to be done, as Landlord deems necessary, and Tenant shall immediately pay to Landlord all costs related thereto plus a charge for overhead of ten percent (10%) of such costs. 6.03 LANDLORD REPAIRS. Except as stipulated herein, Landlord shall not be required to make any improvements to or repairs of any kind or character to the Premises during the Term. However, notwithstanding any provisions of this Lease to the contrary, all repairs, alterations or additions to the Base Building or its systems (as opposed to those involving only Tenant's leasehold improvements), and all repairs, alterations or additions to Tenant's non-Building Standard leasehold improvements which affect the Building's structural components or major mechanical, electrical or plumbing systems in the Building, shall be made only by Landlord (or its contractor) and at commercially competitive rates. Further, to the extent that other provisions of this Lease would make any such repairs, alterations or additions the responsibility of Tenant, Tenant shall pay the cost thereof (including an additional charge of ten percent (10%) of actual direct costs for Landlord's overhead). ARTICLE 7 7.01 LANDLORD INSURANCE. Landlord shall insure the Project and Building against fire and other casualty and shall maintain comprehensive general liability and other insurance in such amounts as may be required by Landlord's mortgagee, or in such other greater commercially reasonable amounts as Landlord, in its sole discretion, may deem appropriate. The cost of such insurance, including any reasonable deductible paid thereunder by Landlord, shall be an "Operating Expense" as defined in Section 3.03 hereof. Such insurance shall be for the sole benefit of Landlord and, if required, Landlord's mortgagee. If the annual premiums to be paid by Landlord exceed the standard rates because of Tenant's operations within or contents of the Premises or because improvements to the Premises are above Building Standard, Tenant shall promptly pay the excess amount of the premium upon request by Landlord (and if necessary, Landlord may allocate the insurance costs of the Building to give effect to this sentence). 7.02 TENANT INSURANCE. Tenant shall, at Tenant's expense, fully insure its property located in the Premises against fire and other casualty and shall maintain comprehensive general liability insurance insuring Landlord and Tenant against any liability arising out of ownership, use, occupancy or maintenance of the Premises and all areas appurtenant thereto, including contractual liability insurance (with respect to Section 7.04 hereof), with insurance companies approved by Landlord and with limits of liability of at least $2,000,000 in each occurrence for Bodily Injury and Property Damage combined and $2,000,000 general aggregate for Bodily Injury and Property Damage combined with the endorsement of comprehensive general liability CG-2504. Tenant shall cause Landlord to be named as an additional insured under such general liability policies and shall, not less than twenty (20) days prior to (a) the 11 13 Commencement Date, and (b) the expiration of old policies, furnish Landlord with certificates of insurance reasonably satisfactory to Landlord. The limit of such insurance shall not, however, limit the liability of Tenant hereunder. Tenant may carry such insurance under a blanket policy, provided such insurance has a Landlord's protective liability endorsement attached thereto. If Tenant fails to procure and maintain said insurance, Landlord may, but shall not be required to, procure and maintain same, but at the expense of Tenant. No policy shall be cancelable or subject to reduction of coverage except after thirty (30) days prior written notice to Landlord. 7.03 WAIVER OF SUBROGATION. WHENEVER (A) ANY LOSS, COST, DAMAGE OR EXPENSE RESULTING FROM FIRE, EXPLOSION OR ANY OTHER CASUALTY OR OCCURRENCE IS INCURRED BY EITHER OF THE PARTIES TO THIS LEASE IN CONNECTION WITH THE PREMISES OR THE PROJECT, AND (B) SUCH PARTY IS THEN COVERED (OR IS REQUIRED UNDER THIS LEASE TO BE COVERED) IN WHOLE OR IN PART BY INSURANCE WITH RESPECT TO SUCH LOSS, COST, DAMAGE OR EXPENSE, THEN NOTWITHSTANDING ANYTHING TO THE CONTRARY HEREIN CONTAINED, THE PARTY SO INSURED (OR REQUIRED TO BE INSURED), FOR ITSELF AND ANY INSURER OR ANYONE ELSE THAT MIGHT OTHERWISE CLAIM THROUGH IT BY WAY OF SUBROGATION, HEREBY RELEASES THE OTHER PARTY (EVEN IF THE OTHER PARTY IS NEGLIGENT) FROM ANY LIABILITY THE OTHER PARTY WOULD OTHERWISE HAVE ON ACCOUNT OF SUCH LOSS, COST, DAMAGE, AND WAIVES ANY RIGHT OF SUBROGATION WHICH MIGHT OTHERWISE EXIST ON ACCOUNT THEREOF. 7.04 TENANT'S INDEMNITY. Tenant hereby indemnifies, defends and holds harmless Landlord and its respective officers, directors, employees and agents, and Landlord's successors and assigns, and their officers, directors, employees and agents (collectively, the "Landlord Indemnified Parties") against any and all claims, demands, losses, liabilities, costs and expenses (including attorneys' fees at trial and on any appeal or petition for review) incurred by the Landlord Indemnified Parties arising from Tenant's use or occupancy of the Premises for the conduct of its business or from any activity, work or other thing done, permitted or suffered by Tenant on or about the Building or the Project, and shall further indemnify defend and hold harmless the Landlord Indemnified Parties from and against any and all claims arising from any breach or default in the performance of any obligation on Tenant's part to be performed under the terms of this Lease, or arising from any act or omission of, or due to the negligence or intentional misconduct of Tenant, or any officer, agent, employee, guest or invitee of Tenant, and from and against all costs, attorneys' fees, expenses and liabilities incurred in or related to any such claim or any action or proceeding brought thereon. Tenant, as a material part of the consideration to Landlord, hereby assumes all risk of damage to property or injury to persons including death in, upon or about the Premises, from any cause, including without limitation, Landlord's negligence, but except for such damage or injury caused solely by Landlord's gross negligence or willful misconduct, and Tenant hereby waives all claims in respect thereof against Landlord. 12 14 7.05 LANDLORD'S INDEMNITY. Landlord hereby indemnifies, defends and holds harmless Tenant and its respective officers, directors, employees and agents, and Tenant's successors and assigns, and their officers, directors, employees and agents (collectively, the "Tenant Indemnified Parties") against any and all claims, demands, losses, liabilities, costs and expenses (including attorneys' fees at trial and on any appeal or petition for review) incurred by the Tenant Indemnified Parties arising from any accident, injury or damages whatsoever caused to any person or the property of any person in or about the common areas or public areas of the Building or the Project (specifically excluding the Premises) to the extent attributable to the gross negligence or willful misconduct of Landlord or its agents and employees. 13 15 ARTICLE 8 8.01 CASUALTY. Tenant shall promptly give Landlord written notice of any fire or other casualty occurring within the Premises. If the Premises or other parts of the Building or Project reasonably required for Tenant's use and quiet enjoyment of the Premises are damaged by fire or other casualty then, subject to the following provisions of this Article, Landlord shall promptly repair the damage. If, however, the damage (a) is not covered by insurance carried by Landlord hereunder, (b) is covered by insurance carried by Landlord hereunder, but Landlord's mortgagee requires that proceeds of such insurance be used to retire the mortgage debt, (c) is to such an extent that the cost of repairs will be greater than 10% of the then full replacement cost of the Building, or (d) occurs during the last 12 months of the then effective Term of this Lease, then Landlord shall have the option (i) to repair the damaged Premises and any other damaged parts of the Building or Project reasonably necessary to Tenant's use and quiet enjoyment of the Premises to substantially the same condition as immediately prior to such fire or other casualty, or (ii) to terminate this Lease by so notifying Tenant within sixty (60) days after the date of such damage, such termination to be effective as of the date of the fire or other casualty causing the damage. Notwithstanding the foregoing, if the Premises are so destroyed that they cannot or will not be repaired or rebuilt within one hundred eighty (180) days of the casualty date, Tenant shall have the option to terminate this Lease by so notifying Landlord within thirty (30) days after Tenant's discovery of such untentability, such termination to be effective as of the date of fire or other casualty causing the damage. The Rent required to be paid hereunder shall be abated in proportion to the portion of the Premises, if any, which is rendered untenantable by fire or other casualty hereunder from the date of the occurrence of such damage or casualty until the repairs specified in clause (i) of the preceding sentence are completed. Other than such rental abatement, no damages, compensation or claims shall be payable by Landlord for loss of the use of the whole or any part of the Premises, Tenant's personal property, or any inconvenience, loss of business, or annoyance arising from any such repair and reconstruction. Landlord shall not be required to repair or replace any furniture, furnishings, or other personal property that Tenant may be entitled to remove from the Premises or any alterations to the Premises constructed and installed by or for Tenant pursuant to Section 6.01 hereof or any installations in excess of Building Standard. ARTICLE 9 9.01 CONDEMNATION. If a "substantial portion of the Premises" (as hereinafter defined) should be taken for any public or quasi-public use, by right of eminent domain or otherwise, or should be sold in lieu of condemnation, then either party hereof shall have the right, at its option, to terminate this Lease as of the date when physical possession of the Premises is taken by the condemning authority. If less than a substantial portion of the Premises is so taken or sold , the Rent payable hereunder shall be abated in proportion to the portion of the Premises which is rendered untenantable by such condemnation, and Landlord shall, to the 14 16 extent Landlord deems feasible, subject to the following provisions of this Article, promptly restore the Premises and the appurtenances thereto to substantially its former condition. As used herein, a "substantial portion of the Premises" will mean (1) more than 20% of the rentable are of the Premises itself, (2) any parking areas or other appurtenances to the Premises in the Project, without which Tenant cannot continue to operate its business in a reasonably normal manner, (3) any part of the Project, after the taking of which (or sale in lieu thereof), Landlord is unable or unwilling to promptly restore the remainder of the Project for any reason (including any shortage of condemnation or sales proceeds available to Landlord or any refusal of Landlord's mortgagee, ground lessor or other secured party, to give consents necessary for such restoration). If any substantial part of the Project other than the Premises may be so taken or sold, Landlord shall have the right at its option to terminate this Lease as of the date when physical possession of such part of the Project is taken by the condemning authority. All amounts awarded upon taking of any part or all of the Project or the Premises shall belong to Landlord and Tenant shall not be entitled to, and expressly assigns all claims, rights and interests to, any such compensation to Landlord. If available, Tenant shall have the right to pursue separately against the condemning authority any award available separately to Tenant for Tenant's moving and relocation expenses, rent differentials, brokerage and attorneys' fees, unamortized improvements (including furnishings) made and paid solely by Tenant, if any, the value, if any, of Tenant's options of renewal, first refusal, and expansion as granted pursuant to Sections 2.03, 2.04, and 2.05, respectively, and other expenses or costs of Tenant reasonably related to such taking or condemnation; provided, however, in no event shall any such award to Tenant reduce or limit the condemnation award payable to Landlord by the condemning authority, and to the extent any award to Tenant would in any manner reduce or limit the award otherwise payable to Landlord, such award shall be payable to Landlord. 15 17 ARTICLE 10 10.01 ENTRY. Landlord, its agents, employees and representatives, shall have the right to enter the Premises at any time during Normal Business Hours after reasonable notice to Tenant under the circumstances (which notice may be oral and not in compliance with Section 15.08 hereof, but no notice shall be required in the case of emergency) to show the Premises to prospective lenders or prospective purchasers or, within the last six (6) months of the Term, to prospective tenants unless Tenant has renewed or extended the Term. Provided any such entry is done in a manner that does not unnecessarily interfere with Tenant's use or enjoyment of the Premises, Tenant hereby waives any claim for damages or for any injury or inconvenience to or interference with Tenant's business, any loss of occupancy or quiet enjoyment of the Premises, and any other loss occasioned thereby, except where such damages or injury are caused by Landlord's gross negligence or willful misconduct. For each of the aforesaid purposes, Landlord shall at all times have and retain a key with which to unlock all of the doors in, upon and about the Premises, excluding Tenant's vaults, safes and files. Landlord shall have the right to use any and all means which Landlord may deem proper to open the doors in, upon and about the Premises in an emergency in order to obtain entry to the Premises without liability to Tenant, except for any failure to exercise due care for Tenant's property. Tenant shall have 24-hour access to the Building and the Premises by card access system ARTICLE 11 11.01 SUBORDINATION. Subject to the nondisturbance provisions in the next Section, this Lease is and shall be subject and subordinate to any and all ground or similar leases affecting the Project, and to all mortgages, deeds of trust, and security agreements that may now or hereafter encumber or affect the Project or any interest of Landlord therein and/or the contents of the Building, and to any advances made on the security thereof and to any and all increases, renewals, modifications, consolidations, replacements and extensions of any such leases, mortgages, deeds of trust and/or security agreements. This clause shall be self-operative and no further instrument of subordination need be required by any owner or holder of such ground lease, mortgage, deed of trust or security agreement. Tenant agrees to execute and return any estoppel certificate, consent or agreement reasonably requested by any such lessor, mortgagee, trustee or secured party in connection with this Section within ten (10) days after Tenant's receipt of same, Tenant's receipt being governed by Section 15.08 of this Lease. Any breach of the preceding sentence by Tenant shall constitute a "Default" hereunder. If any mortgagee of Landlord secured by a lien on the Project, any lessor to Landlord under a ground lease of the Project, or any secured party under a security agreement encumbering the interest of Landlord shall request it and provide Tenant with an address for notices, Tenant shall provide to such mortgagee, lessor or secured party written notice of any default or breach by Landlord at least thirty (30) days prior to the exercise by Tenant of any rights and/or remedies of Tenant hereunder 16 18 arising out of such default or breach. Provided Tenant is not in default hereunder, within ten (10) days following receipt of a written request therefor, Landlord agrees to execute and return any estoppel certificate, consent or agreement reasonably requested by Tenant or any mortgagee, trustee, or secured party reasonably interested in the Premises. 11.02 NONDISTURBANCE AND ATTORNMENT. If any ground or similar such lease, mortgage, deed of trust or security agreement is enforced by the ground lessor, the mortgagee, the trustee, or the secured party, Tenant shall, upon request, attorn to the lessor under such lease or the mortgagee or purchaser at such foreclosure sale, or any person or party succeeding to the interest of Landlord as a result of such enforcement, as the case may be, and execute instrument(s) confirming such attornment; provided, however, that regardless of whether this Lease was approved and accepted in writing by such lessor, mortgagee, trustee or secured party, Tenant's attornment and the rights of the lessor, mortgagee, trustee or secured party (or anyone else claiming through them) shall be conditioned upon the agreement by such successor to Landlord's interest not to disturb Tenant's possession or other rights hereunder during the Term so long as Tenant performs its obligations under this Lease. In the event of such enforcement and upon Tenant's attornment as aforesaid, Tenant will automatically become the tenant of the successor to Landlord's interest without change in the terms or provisions of this Lease; provided, however, that such successor to Landlord's interest shall not be (a) bound by any payment of Rent for more than one month in advance (except prepayments for security deposits, if any), or (b) bound by any amendments or modifications of this Lease made without the prior written consent of the applicable mortgagee or secured party after Tenant has been notified of its name and address, or (c) subject to liability or offset for any damages Tenant may claim because of a default by Landlord hereunder prior to the date Landlord's interest in the Building is conveyed to such successor of Landlord. 11.03 QUIET ENJOYMENT. Tenant, on paying the Rent and keeping and performing the conditions and covenants herein contained, shall and may peaceably and quietly enjoy the Premises for the Term, subject to Sections 11.01 and 11.02, all applicable laws and other governmental and legal requirements and the provisions of this Lease. It is understood and agreed that this covenant and any and all other covenants of Landlord contained in this Lease shall be subject to the penultimate sentence of Section 15.07. 17 19 ARTICLE 12 12.01 ASSIGNMENT AND SUBLETTING. Tenant shall have the right, without Landlord's consent, to assign this Lease in its entirety, or to sublet all or any part of the Premises to (a) a subsidiary or affiliate of Tenant; (b) any partnership succeeding to the business and assets of Tenant; or (c) a successor entity created by merger, reorganization, recapitalization, or acquisition. For purposes of this Section, the word "affiliate" shall mean an entity, directly or indirectly, through one or more intermediaries, controlled by Tenant or under common control with Tenant, or by Tenant's parent company. Except as set forth above, Tenant shall not, voluntarily, by operation of law, or otherwise, assign, transfer, mortgage, pledge, or encumber this Lease or sublease the Leased Premises or any part thereof, or suffer any person other than Tenant, its employees, agents, servants and invitees to occupy or use the Leased Premises or any portion thereof without the express prior written consent of Landlord which consent shall not be unreasonably withheld; provided, however, any such assignee or sublessee must be creditworthy, must use the Leased Premises for the specific uses set forth in Article 4, must not be a type a type or class of tenant that would reduce the value of the Project as a first class office building project, and Landlord shall not be required to give its consent to a sublease or assignment that would result in a breach by Landlord of any of its lease obligations to other tenants. Any attempt to do any of the foregoing without such written consent shall be null and void and of no effect, and shall further constitute a default under this Lease. If Tenant so requests Landlord's consent, said request shall be in writing specifying the identity of the proposed transferee, the duration of said desired sublease or assignment, the date same is to occur, the exact location of the space affected thereby and the proposed rentals on a square foot basis chargeable thereunder, and shall be submitted to Landlord at least fifteen (15) days in advance of the date on which Tenant desires to make such assignment or sublease or allow such occupancy or use. Upon such request Landlord may, in its reasonable discretion, (a) grant such consent subject to Landlord's approval of the assignee, transferee, subtenant, or mortgagee, or (b) deny such consent, which denial shall not be effective unless Landlord provides Tenant with a written explanation of the reason(s). If Landlord does not give such consent in writing within ten (10) days of the date such consent is requested, then Landlord's consent shall be deemed to have been granted. In no event may Tenant assign this Lease or sublease the Leased Premises or any portion thereof to any party whose operations in the Project would not be in keeping with, or would detract from, the operations of other tenants in the Project. In any situation in which Landlord consents to an assignment or sublease hereunder, Tenant shall promptly deliver to Landlord a fully executed copy of the final sublease agreement or assignment instrument and all ancillary agreements relating thereto. No assignment shall be effective unless the assignee has agreed within the assignment instrument to assume the obligations of Tenant hereunder and to be personally bound by all of the covenants, terms and conditions hereof on the part of Tenant to be performed or observed hereunder. 18 20 12.02 CONTINUED LIABILITY. Tenant shall, despite any permitted assignment or sublease, remain directly and primarily liable for the performance of all of the covenants, duties, and obligations of Tenant hereunder, and Landlord shall be permitted to enforce the provisions of this Lease against Tenant or any assignee or sublessee without demand upon or proceeding in any way against any other person. 12.03 CONSENT. Consent by Landlord to a particular assignment or sublease shall not be deemed a consent to any other or subsequent transaction. If this Lease is assigned or if the Premises are subleased without the permission of Landlord, then Landlord may nevertheless collect Rent from the assignee or sublessee and apply the net amount collected to the Rent payable hereunder, but no such transaction or collection of Rent or application thereof by Landlord shall be deemed a waiver of any provision hereof or a release of Tenant from the performance of the obligations of the Tenant hereunder. 12.04 PROCEEDS. All cash or other proceeds of any assignment or sublease of Tenant's interest in this Lease and/or the Premises, whether consented to by Landlord or not, in excess of the rentals called for hereunder, shall be paid first to pay all reasonable out-of-pocket costs and expenses paid by Tenant related to such sublease or assignment of the Premises, including leasing commission and tenant improvements costs, and thereafter, fifty percent (50%) of such excess rentals shall be paid to Landlord and fifty percent (50%) shall be paid to Tenant, unless Tenant is in default hereunder, in which event all excess rentals shall be paid to Landlord during the continuance of such default. After the payment of all reasonable out-of-pocket costs and expenses related to such sublease or assignment, Tenant hereby covenants and agrees to pay to Landlord fifty percent (50%) of all rent and other consideration which it receives which is in excess of the rent payable hereunder within ten (10) days following receipt thereof by Tenant; provided that during the occurrence of an event of default hereunder by Tenant, Tenant covenants to pay to Landlord one hundred percent (100%) of such excess rentals within ten (10) days following receipt thereof by Tenant. This covenant and assignment shall benefit Landlord and its successors in ownership of the Building and shall bind Tenant and Tenant's heirs, executors, administrators, personal representatives, successors and assigns. In addition to any other rights and remedies which Landlord may have hereunder, at law or in equity, in the event Tenant has failed to pay any rent due hereunder on or before five (5) days following the date on which it is due, Landlord shall have the right to contact any assignee and require that from that time forward all payments made pursuant to the assignment shall be made directly to the Landlord. Any assignee or sublessee of Tenant's interest in this Lease (all such assignees or sublessees being hereinafter referred to as "Successors"), by occupying the Premises and/or assuming Tenant's obligations hereunder, shall be deemed to have assumed liability to Landlord for all amounts paid to persons other than Landlord by such Successors in consideration of any such assignment in violation of the provisions hereof. 19 21 ARTICLE 13 13.01 DEFAULT. Each of the following shall constitute a "Default" by Tenant: (a) The failure of Tenant to pay the Rent or any part thereof when due and the continuation of such failure for five days after Tenant is notified in writing thereof; provided, however, that if Tenant fails to make any payment required by this Lease when due two (2) or more times in any Lease Year, then notwithstanding that such defaults have been cured by Tenant, any further similar failure shall be deemed a Default without notice or opportunity to cure; (b) Tenant shall become insolvent or unable to pay its debts as they become due, or Tenant notifies Landlord that it anticipates either condition; (c) Tenant takes any action to, or notifies Landlord that Tenant intends to, file a petition under any section or chapter of the United States Bankruptcy Code, as amended from time to time, or under any similar law or statute of the United States or any state thereof; or a petition shall be filed against Tenant under any such statute or Tenant notifies Landlord that it knows such a petition will be filed; or the appointment of a receiver or trustee to take possession of substantially all of Tenant's assets located at the Premises or of Tenant's interest in this Lease; or the attachment, execution or other judicial seizure of substantially all of Tenant's assets located at the Premises or of Tenant's interest in this Lease; unless the application of this subsection 13.01(c) shall contravene any applicable law; (d) Tenant shall fail to fulfill or perform, in whole or in part, any of its obligations under this Lease (other than the payment of Rent) and such failure or nonperformance shall continue for a period of fifteen (15) days after written notice thereof has been given by Landlord to Tenant; but if the failure is of a nature that it cannot be cured within such 15-day period, Tenant shall not have committed a Default if Tenant commences the curing of the failure within such 15-day period and thereafter diligently pursues the curing of same and completes the cure within thirty (30) days; (e) Tenant shall fail to take possession of the Premises within ninety (90) days after the Commencement Date; (f) Tenant shall vacate or abandon the Premises or any significant portion thereof for a period in excess of ninety (90) days, except in connection with an assignment or sublease of the Premises or a significant portion thereof approved by Landlord or 20 22 an abandonment or vacation otherwise approved by Landlord, in its sole discretion; and (g) The occurrence of any event or condition having a material and adverse effect on the assets, liabilities, financial condition, business or operations of Tenant as they exist on the date of this Lease, or the ability of the Tenant to meet its obligations under this Lease on timely basis; (h) Any representation or warranty by Tenant in this Lease, or any certificate or other document furnished by Tenant to induce Landlord to enter into this Lease, including without limitation, financial information, proves to be incorrect in any material respect. 13.02 RIGHTS UPON DEFAULT. If a Default by Tenant occurs, then at any time thereafter, with or without notice or demand, Landlord may exercise any and all rights and remedies available to Landlord under this Lease, at law or in equity, statutory or at common law, including without limitation, termination of this Lease and termination of Tenant's right to possession without terminating the Lease. In the event of a Default, Landlord may, without additional notice and without court proceedings, re-enter and repossess the Premises and remove all persons and property therefrom, and Tenant hereby agrees to surrender possession of the Premises, waives any claim arising by reason thereof or by reason of issuance of any distress warrant or writ of sequestration, and agrees to hold Landlord harmless from any such claims. If Landlord elects to terminate this Lease, it may treat the Default as an entire breach of this Lease and Tenant shall immediately become liable to Landlord for damages equal to the total of (a) the cost of recovering, reletting, including, without limitation, the cost of leasing commissions attributable to the unexpired portion of the Term of this Lease, and remodeling of the Premises for a normal and customary office tenant, (b) all unpaid Rent and other amounts earned or due through such termination, including interest thereon at the rate specified in Section 13.04 hereof, plus (c) the present value (discounted at the rate of eight percent (8%) per annum) of the balance of the Rent for the remainder of the Term less the present value (discounted at the same rate) of the fair market rental value of the Premises for said period and (d) any other sum of money and damages owed by Tenant to Landlord. If Landlord elects to terminate Tenant's right to possession of the Premises without terminating this Lease, Landlord may (but shall not be obligated to) rent the Premises or any part thereof for the account of Tenant to any person or persons for such rent and for such terms and conditions as Landlord reasonably deems appropriate, and Tenant shall be liable to Landlord for the amount, if any, by which the Rent for the unexpired balance of the Term exceeds the net amount, if any, received by Landlord from such reletting, being the gross amount so received by Landlord less the costs of repossession, reletting, remodeling, and other expenses incurred by Landlord. Such sum or sums shall be paid by Tenant in monthly installments on the first day of each month of the Term. In no case shall Landlord be liable for failure to relet the Premises or to collect the rent due under such reletting, 21 23 and in no event shall Tenant be entitled to more than 50% of any excess rents received by Landlord. All rights and remedies of Landlord shall be cumulative and not exclusive. Landlord shall use commercially reasonable efforts to mitigate Tenant's damages in the event of Tenant's default. 13.03 COSTS. If a Default by Tenant occurs, then Tenant shall reimburse Landlord on demand for all costs reasonably incurred by Landlord in connection therewith including, but not limited to, reasonable attorney's fees, court costs, and related costs, plus interest thereon from the date such costs are paid by Landlord until Tenant reimburses Landlord, at the rate specified in Section 13.04 hereof. 13.04 INTEREST. All late payments of Rent, costs or other amounts due from Tenant under this Lease shall bear interest from the date due until paid at the rate of eighteen percent (18%) per annum; provided, however, in no event shall the rate of interest hereunder exceed the maximum non-usurious rate of interest (the "Maximum Rate") permitted by the applicable laws of the State of Texas or the United States of America, whichever shall permit the higher non-usurious rate, and as to which Tenant could not successfully assert a claim or defense of usury. 13.05 INTENTIONALLY OMITTED 13.06 SECURITY DEPOSIT. Upon the execution of this Lease, Tenant shall deposit with Landlord $88,333.00 as a security deposit (the "Security Deposit"). The Security Deposit shall be held by Landlord without liability for interest and as security for the performance by Tenant of Tenant's covenants and obligations under this Lease, it being expressly understood that the Security Deposit shall not be considered an advance payment of rent or a measure of Tenant's liability for damages in case of Default by Tenant. Landlord shall have no fiduciary responsibilities or trust obligations whatsoever with regard to the Security Deposit and shall not assume the duties of a trustee for the Security Deposit. Landlord may, from time-to-time, without obligation and without prejudice to any other remedy and without waiving such Default, use the Security Deposit to the extent necessary to cure any Default of Tenant hereunder; provided, however, Landlord has no obligation to use the Security Deposit to cure any Default of Tenant. Following any such application of the Security Deposit, Tenant shall pay to Landlord on demand in cash the amount so applied in order to restore the Security Deposit to its original amount. If Tenant is not in Default at the termination of this Lease, the balance of the Security Deposit remaining after any such application shall be returned by Landlord to Tenant. If Landlord transfers its interest in the Premises during the term of this Lease, and the transferee accepts all legal obligations of Landlord under the Lease, Landlord may assign the Security Deposit to the transferee and thereafter shall have no further liability for the return of such Security Deposit. Tenant agrees to look solely to such transferee or assignee or successor thereof for the return of the Security Deposit. Landlord and its successors and assigns shall not be bound by any actual or attempted assignment or encumbrance of the Security Deposit by Tenant. 22 24 Tenant, at its option, may substitute a letter of credit for the cash Security Deposit; provided, however, such letter of credit must be in a form and content acceptable to Landlord, in its sole and absolute discretion. 13.07 NON-WAIVER. The failure of Landlord or Tenant to seek redress for violation of, or to insist upon the strict performance of, any covenant or condition of this Lease shall not prevent a subsequent act or omission that would have originally constituted a violation of this Lease from having all the force and effect of an original violation. The receipt by Landlord of Rent with or without knowledge of the breach of any provision of this Lease shall not be deemed a waiver of such breach, shall not reinstate this Lease or Tenant's right of possession if either or both have been terminated, and shall not otherwise affect any notice, election, action, or suit by Landlord. No provision of this Lease shall be deemed to have been waived unless such waiver is in writing signed by the waiving party. No act or thing done by Landlord during the Term shall be deemed an acceptance of a surrender of the Premises and no agreement to accept such surrender shall be valid, unless express and in writing signed by Landlord. ARTICLE 14 14.01 FINANCIAL STATEMENTS. Within sixty (60) days after the end of each fiscal year of Tenant, or as may be requested from time to time by Landlord, Tenant shall deliver to Landlord current financial statements, including, without limitation, balance sheets, profit and loss statements, reconciliations of capital and surplus, changes in financial condition, schedules of sources and applications of funds, and operating statements with respect to the business of Tenant, all of which shall, at the request of Landlord, be certified by an independent certified public accountant. 14.02 EVIDENCE OF AUTHORITY. Simultaneously with the execution and delivery of this Lease, Tenant shall deliver a fully executed Certificate of the Secretary, with attached Resolutions of its corporate board, indicating the authority of the person executing this Lease on behalf of Tenant, substantially in the form attached hereto as Exhibit "H". ARTICLE 15 15.01 AMENDMENT. Any agreement hereafter made between Landlord and Tenant shall be ineffective to modify, release, or otherwise affect this Lease, in whole or in part, unless such agreement is in writing and signed by the party to be bound thereby. 15.02 SEVERABILITY. If any term or provision of this Lease shall, to any extent, be held invalid or unenforceable by a final judgment of a court of competent jurisdiction, the remainder of this Lease shall not be affected thereby. 23 25 15.03 ESTOPPEL LETTERS. Tenant shall promptly upon request from Landlord execute and acknowledge a certificate containing such information as may be reasonably requested for the benefit of Landlord, any prospective purchaser or any current or prospective mortgagee of all or any portion of the Project. Landlord shall promptly upon request from Tenant execute and acknowledge a certificate containing such information as may be reasonably requested for the benefit of Tenant, any prospective transferee or any current or prospective mortgagee of all or any portion of the Premises. 15.04 LANDLORD'S LIABILITY AND AUTHORITY. The liability of Landlord to Tenant for any default by Landlord under the terms of this Lease shall be limited to the interest of Landlord in the Building, it being intended that Landlord, its officers, directors and employees shall not be personally liable for any judgment or deficiency. Whenever in this Lease there is imposed upon Landlord or Tenant the obligation to use its best efforts, reasonable efforts, diligence or act in good faith, Landlord or Tenant, as the case may be, shall be required to do so only to the extent the same is economically feasible and otherwise will not impose upon Landlord extreme burdens, financial or otherwise. 15.05 HOLDOVER. If Tenant shall remain in possession of the Premises after the Expiration Date or earlier termination of this Lease, then Tenant shall be deemed a tenant-at-will whose tenancy is terminable at any time. In such event, Tenant shall pay Rent at 150% the daily Rent prevailing on the date of such termination or expiration for the first ninety (90) days of such holdover, and 200% the daily Rent prevailing on the date of such termination or expiration thereafter, but otherwise shall be subject to all of the obligations of Tenant under this Lease. Additionally, Tenant shall pay to Landlord all damages sustained by Landlord on account of such holding over by Tenant. 15.06 SURRENDER. Upon the expiration or earlier termination of the Term, Tenant shall peaceably quit and surrender the Premises in the condition required by Sections 6.01 and 6.02 hereof. All obligations of Tenant for the period of time prior to the expiration or earlier termination of the Term shall survive such expiration or termination. 15.07 PARTIES AND SUCCESSORS. Subject to the limitations and conditions set forth elsewhere herein, this Lease shall bind and inure to the benefit of the respective heirs, legal representatives, successors, and permitted assigns and/or sublessees of the parties hereto. The term "Landlord", as used in this Lease, so far as the performance of any covenants or obligations on the part of Landlord under this Lease are concerned, shall mean only the owner of the Project at the time in question, so that in the event of any transfer of title to the Project, the party by whom any such transfer is made shall have no liability for a breach of any obligations of the Landlord under this Lease after the date of such transfer, and the party to whom any such transfer is made shall have no liability for any breach of the obligations of the Landlord under this Lease before the date of the transfer. Landlord shall have the right to transfer, sell, assign, 24 26 mortgage or encumber, in whole or in part, all of its rights and obligations hereunder and in the Building, the Land, the Project and other property of Landlord referred to herein. 15.08 NOTICE. Except as otherwise provided herein, any statement, notice, demand or other communication provided for or required to be given pursuant to this Lease shall be in writing and served on the parties at the addresses listed below. Any notice shall be either (a) personally delivered to the address set forth below, in which case it shall be deemed delivered on the date of delivery to the addressee; or (b) sent by registered or certified mail/return receipt requested, in which case it shall be deemed delivered three (3) business days after deposited in the U.S. Mail; (c) sent by a nationally recognized overnight courier, in which case it shall be deemed delivered one (1) business day after deposit with such courier; or (d) sent by telecommunications ("Fax") in which case it shall be deemed delivered on the day sent, provided an original is received by the addressee by hand delivery or by a nationally recognized overnight courier within one (1) business day of the Fax. The addresses and Fax number listed herein may be changed by written notice to the other parties, provided, however, that no notice of a change of address or Fax number shall be effective until date of delivery of such notice. Copies of notice are for informational purposes only and a failure to give or receive copies of any notice shall not be deemed a failure to give notice. For purposes of notice, the addresses of the parties shall be as follows: If to Landlord: Investors Life Insurance Company of North America Attn: James M. Grace 701 Brazos, Suite 1400 Austin, Texas 78701 Facsimile No. (512) 404-5051 If to Tenant: eLoyalty Corporation Attn: Tony Lapetina Suite 1000 1050 Winter Street Waltham, Massachusetts 02451 Facsimile No. (781) 530-3638 and eLoyalty Corporation Attn: Susan Seah, Esq. 150 North Field Drive Lake Forest, Illinois 60045 25 27 15.09 RULES AND REGULATIONS. Tenant, its servants, employees, agents, visitors, invitees, and licensees, shall observe faithfully and comply strictly with the Rules and Regulations set forth in Exhibit "I" hereto, and shall abide by and conform to such further reasonable non-discriminatory Rules and Regulations as Landlord may from time to time make, amend or adopt, after Tenant receives a copy thereof. 15.10 CAPTIONS. The captions in this Lease are inserted only as a matter of convenience and for reference and they in no way define, limit, or describe the scope of this Lease or the intent of any provision hereof. 15.11 NUMBER AND GENDER. All genders used in this Lease shall include the other genders, the singular shall include the plural, and the plural shall include the singular, whenever and as often as may be appropriate. 15.12 GOVERNING LAW. This Lease shall be governed by and construed in accordance with the laws of the State of Texas. 15.13 INABILITY TO PERFORM. Notwithstanding Section 15.18 hereof, whenever a period of time is herein prescribed for the taking of any action by Landlord or Tenant, such party shall not be liable or responsible for, and there shall be excluded from the computation of such period of time, any delays due to strikes, riots, acts of God, shortages of labor or materials, war, governmental laws, regulations or restrictions, or any other cause whatsoever beyond the control of such party (financial inability or hardship excepted), and such nonperformance or delay in performance shall not constitute a breach or default by such party under this Lease nor give rise to any claim against such party for damages or constitute a total or partial eviction, constructive or otherwise: provided, however, this provision shall not excuse any delay in, or extend the time periods set forth herein for Landlord's or Tenant's making of payments required by this Lease. 15.14 USE OF NAME. Tenant shall not, except to designate Tenant's business address (and then only in a conventional manner and without emphasis or display), use the name or mark "River Place Pointe" or "River Place Pointe II" for any purpose whatsoever. 15.15 BROKERS. Tenant represents and warrants that only brokers Tenant has dealt with in connection with this lease are Greg Johnston of Colliers Oxford Commercial, Inc. and Michael J. Burns of Burns & Company, which represent Tenant, and S. Tim Casey of FIC Realty Services, Inc., which represents Landlord. Tenant also represents that, insofar as Tenant knows, no other brokers negotiated this Lease or are entitled to any commission in connection herewith. Tenant shall indemnify and hold harmless Landlord from and against all claims (and costs of defending against and investigating such claims) of any other brokers or similar parties claiming under Tenant in connection with this Lease. The brokers acknowledge and agree that they have entered into Leasing Commission Agreements with Landlord, and such Leasing Commission 26 28 Agreements govern the payment of commissions to the brokers in this transaction. The brokers further acknowledge and agree that the commissions provided for under the Leasing Commission Agreement are not earned until this Lease has been fully executed by all parties hereto, and one-half (1/2) of the commission is payable upon the full execution of the Lease by all parties hereto, and the remaining one-half (1/2) of the commission is payable upon Tenant's occupancy of the Premises and the payment of the first months rent by Tenant. 15.16 PARKING. Tenant shall have the right to use the parking facilities of the Building, including the visitor parking spaces, subject to the rules and regulations for such parking facilities as set forth in Exhibit "I" hereto. Tenant shall be entitled to one (1) parking space per 250 rentable square feet contained in the Premises, such parking spaces to be surface parking spaces and spaces in the Project as determined by Landlord. In addition, for a period of sixty (60) days from the Commencement Date, Tenant shall be entitled to lease a proportionate number of executive parking spaces located beneath the Building (based on the ratio of the rentable square feet in the Premises bears to the total rentable square feet in the Building applied to the total number of executive parking spaces located under the Building) at an additional cost of $100.00 per space per month, and such amounts shall be in addition to the Rent. After the expiration of sixty (60) days from the Commencement Date, executive parking spaces may only be leased by Tenant on a space available basis, and the leasing of such executive parking spaces shall be subject to the sole and absolute discretion of the Landlord. Any executive parking spaces leased by Tenant shall be counted against the 1 space to 250 rentable square feet allocation set forth above. Tenant shall comply with all traffic, security, safety and other rules and regulations concerning parking as are reasonably promulgated from time to time by Landlord. Tenant shall indemnify and hold harmless Landlord from and against all claims, losses, liabilities, damages, costs and expenses (including, but not limited to, attorneys' fees and court costs) arising out of Tenant's use of any such parking spaces, whether or not caused or alleged to be caused by Landlord's negligence. 15.17 SIGNAGE. Interior signage, suite identity and lobby directories will be provided by Landlord, and Tenant will have access to the Building directory for its signage, consistent with the Building directory signage adopted by Landlord. In addition, if Landlord installs a monument sign for the Building, Tenant shall have non-exclusive access to such Building monument sign, such signage to be approved by Landlord, which approval shall not be unreasonably withheld, as long as any such monument signage is consistent with the monument signage in the Project. Landlord is under no obligation to install a monument sign at the Building. 15.18 TIME OF ESSENCE. Time is of the essence of this Lease and each and all of its provisions in which performance is a factor. 27 29 15.19 TENANT TAXES. Tenant shall pay, or cause to be paid, before delinquency, any and all taxes levied or assessed and which become payable during the Term upon all of Tenant's non-Building Standard leasehold improvements and all of Tenant's equipment, furniture, fixtures and personal property located in the Premises. 15.20 ATTORNEY'S FEES. In the event either party defaults or is alleged to have defaulted in the performance of any of the terms, agreements or conditions contained in this Lease and the other party places the enforcement of this Lease, or any part thereof, or the collection of any amount due or to become due hereunder, or recovery of the possession of the Premises, in the hands of any attorney who files suit upon the same, the prevailing party in the suit shall be entitled to recover its reasonable attorney's fees from the other party. 15.21 LANDLORD ALTERATIONS OR MODIFICATIONS. Subject to the other provisions hereof, Landlord expressly reserves the right in its sole discretion to temporarily or permanently change the location of, close, block or otherwise alter any entrances, corridors, skywalks, tunnels, doorways, or walkways leading to or providing access to the Building or any part thereof or otherwise restrict the use of same, provided such acts do not materially and adversely impair Tenant's access to the Premises, do not detract from the appearance of the Premises, and do not otherwise interfere with Tenant's use and enjoyment of the Premises. Landlord shall not incur any liability whatsoever to Tenant as a consequence of acts authorized by this provision, and such acts shall not be deemed to be a breach of any of Landlord's obligations hereunder. Landlord agrees to exercise good faith in notifying Tenant within a reasonable time in advance of any alterations, modification or other acts of Landlord under this Section. 15.22 NAME CHANGE. Landlord and Tenant covenant and agree that Landlord hereby reserves and shall have the right at any time and from time to time to change the name of the Building as Landlord may deem advisable, and Landlord shall not incur any liability whatsoever to Tenant as a consequence thereof, except that Landlord shall reimburse Tenant for the reasonable costs of replacement of Tenants stationary, signage, and the like due to such changes. Landlord may not change the name of the Building at the request or direction of or with the intent to place emphasis upon any tenant in the Building with less rentable space than Tenant in the Project, unless such tenant (or a parent, subsidiary or affiliate of such tenant) is the owner of the Building or the Project. 15.23 ENTIRE AGREEMENT. This Lease, including all Exhibits attached hereto (which Exhibits are hereby incorporated herein and shall constitute a portion hereof), contains the entire agreement between Landlord and Tenant with respect to the subject matter hereof. Tenant hereby acknowledges and agrees that neither Landlord nor Landlord's agents or representatives have made any representations, warranties, or promises with respect to the Project, the Premises, Landlord's services, or any other matter or thing except as herein expressly 28 30 set forth, and no rights, easements, or licenses are acquired by Tenant by implication or otherwise except as expressly set forth in this Lease. The taking of possession of the Premises by Tenant shall be conclusive evidence, as against Tenant, that Tenant accepts the Premises and the Project, and that same were in good and satisfactory condition at the time such possession was so taken, subject to punch list items and latent defects. Further, the terms and provisions of this Lease shall not be construed against or in favor of a party hereto merely because such party is the "Landlord" or the "Tenant" hereunder or such party or its counsel is the draftsman of this Lease. 15.24 RIGHT OF TERMINATION. Subject to the terms and conditions of Exhibit "G" attached hereto, if Tenant timely exercises the Expansion Option and Landlord is unable to accommodate Tenant's expansion needs (up to 16,414 rentable square feet) either (i) in the Expansion Space, or (ii) in the event Tenant has not exercised its Right of First Refusal as to a portion of the Expansion Space, in other space in the Building or the Project with respect to said portion reasonably acceptable to Tenant (as more clearly illustrated at Exhibit "G"), then Tenant shall have the right to cancel and terminate this Lease as of May 31, 2003, by giving Landlord written notice of such election no later than December 1, 2002; provided, however, in order for Tenant to cancel and terminate this Lease, Tenant must pay, prior to May 31, 2003, liquidated damages to Landlord equal to the unamortized costs incurred by Landlord in connection with this Lease, including, but not limited to, Tenant Improvements constructed by Landlord, Additional Tenant Improvements constructed by Landlord, and leasing commissions. (REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK; SIGNATURE PAGE FOLLOWS) 29 31 EXECUTED as of the date first written above. LANDLORD: INVESTORS LIFE INSURANCE COMPANY OF NORTH AMERICA By: ____ Name: Title: TENANT: eLOYALTY CORPORATION By: Name: Title: EXHIBITS: EXHIBIT "A": FLOOR-PLANS EXHIBIT "B": LEGAL DESCRIPTION EXHIBIT "C": BASE BUILDING, TENANT IMPROVEMENTS AND TENANT IMPROVEMENT ALLOWANCE EXHIBIT "D": COMMENCEMENT DATE DECLARATION EXHIBIT "E": RENEWAL OPTION EXHIBIT "F": RIGHT OF FIRST REFUSAL EXHIBIT "G": EXPANSION OPTION EXHIBIT "H": CERTIFICATE OF THE SECRETARY EXHIBIT "I": RULES AND REGULATIONS 30 32 EXHIBIT "A" TO LEASE BETWEEN INVESTORS LIFE INSURANCE COMPANY OF NORTH AMERICA AS LANDLORD, AND eLOYALTY CORPORATION, AS TENANT RIVER PLACE POINTE II FLOOR-PLANS 31 33 INITIALED FOR IDENTIFICATION BY LANDLORD AND TENANT 2 34 EXHIBIT "B" TO LEASE BETWEEN INVESTORS LIFE INSURANCE COMPANY OF NORTH AMERICA AS LANDLORD AND eLOYALTY CORPORATION, AS TENANT LEGAL DESCRIPTION OF THE LAND TRACT I Lots 1-8, Block A, River Place Section 20, a subdivision in Travis County, Texas, according to the map or plat thereof recorded in Volume 95, Pages 99-102 of the Plat Records of Travis County, Texas. AND TRACT II METES AND BOUNDS DESCRIPTION OF A 0.345 ACRE TRACT AS RECORDED IN VOLUME 8210, PAGE 723 OF THE TRAVIS COUNTY DEED RECORDS, TRAVIS COUNTY, TEXAS AND BEING LOCATED IN THE ALEXANDER DUNLAP SURVEY NO. 805, ABSTRACT 224, SAID 0.345 ACRE TRACT BEING DESCRIBED AS FOLLOWS: BEGINNING at 1/4-INCH iron rod found marking the northwest corner of the Charles Webb 0.50 acre tract as recorded in Volume 7641, Page 112 of the Travis County Deed Records. same being a re-entrant comer in the northerly one of the First River Place Reserve Ltd. 1441.33 acre tract as recorded in Volume 11379, Page 379 of the Travis County Deed Records, and being in the northerly line of the Banyan Payne Survey No. 288, Abstract No. 640 and the southerly line of the Alexander Dunlap Survey No. 805, Abstract No. 224; THENCE N 59- 34' 01" W, with the said survey line 270.92 feet to a 1/2-inch iron rod set in the southerly line of the Bryan H. Montandon called 3.629 acre tract as recorded in Volume 9450, Page 944 of the Travis County Deed Records, same being the southerly line of a 100-foot wide L.C.R.A. easement as recorded in Volume 611, Page 616 of the Travis County Deed Records, from which a 1/2-inch iron rod found bears S 83- 01'26" W, 0.95 feet; THENCE N 83- 01'26" E, with said southerly line of the Bryan H. Montandon tract and the L.C.R.A. easement passing at 166.56 feet a 1-1/4 inch hex bolt found, in all 167.29 feet to a 1/2 3 35 inch iron rod set in the westerly right-of-way line of Ranch to Market Road 2222, 80 foot wide at this point; THENCE with the said westerly right-of-way of Ranch to Market Road 2222, S 27- 35' 26" E, 156.79 feet to a 1/2 inch iron rod set at the point of curvature of a curve to the left; THENCE southeasterly with said curve to the left and the west right-of-way line, passing through a central angle of 04- 22' 15" to a 1/2 inch iron rod set, said curve having a radius of 490.67 feet, an arc length of 37.43 feet and a chord bearing S 29- 46' 47" E 37.42 feet; THENCE departing said west right-of-way line, N 59- 34' 01" W, with the aforementioned survey line 27.44 feet to the POINT OF BEGINNING and containing 0.345 acres of land. 2 36 INITIALED FOR IDENTIFICATION BY LANDLORD AND TENANT 3 37 EXHIBIT "C" TO LEASE BETWEEN INVESTORS LIFE INSURANCE COMPANY OF NORTH AMERICA, AS LANDLORD, AND eLOYALTY CORPORATION, AS TENANT BASE BUILDING, TENANT IMPROVEMENTS AND TENANT IMPROVEMENT ALLOWANCE 1. Base Building. Landlord shall, at its sole cost and expense, construct the Base Building in a good and workmanlike manner and in accordance with all applicable laws and restrictive covenants affecting the Project. The Base Building is specifically described in the Base Building Plans prepared by the architectural firm Graeber, Simmons & Cowan, dated 4/12/99 and 5/28/99, under Job No. 9816900. The Base Building Plans are incorporated herein by reference for all purposes. The Base Building includes the foundation, structural walls, exterior facade, exterior glass, roof, mechanical equipment and systems, electrical systems, plumbing systems, atrium, elevator shafts, cabs and lobbies, rest rooms, corridors required by code for building access, Building Standard window treatments, and certain Base Building finishes as set forth below. For purposes of this Lease, the Base Building will also be deemed to include the allocated surface parking, allocated space within the Parking Garage I, building loading zones, and common areas located on the Land. The Base Building and Base Building finishes shall include the following: Floor: Exposed structural concrete slab. Walls: The interior of exterior walls and partitions separating tenant spaces from public spaces shall be taped and floated, but not finished on the Tenant side. Columns: Exterior columns shall have gypsum board furring enclosures, with taped and floated finish. All other columns shall be left exposed. Ceiling: A suspended ceiling grid system and ceiling tiles shall be provided and stacked on each floor of the Building; provided, however, if Tenant elects not to utilize the suspended ceiling grid system and ceiling tiles provided by Landlord, then Tenant shall receive a credit in the Tenant Improvement Allowance for all or such portion of the ceiling grid system and ceiling tiles, but only to the extent Landlord can reasonably use same in other portions of the Project. 4 38 Lighting: Lighting only in public areas, no lighting in Tenant spaces; provided, however, Tenant shall receive a full credit in the Tenant Improvement Allowance of $65.00 per fixture for Building Standard 2' X 4' parabolic lay-in fluorescent light fixtures for each one hundred sixteen (116) square feet of rentable area in the Premises. Exit Corridors: Code required exit corridors. Riser Sleeves: Sleeves will be provided at the back of the stairwells for use by Tenant for electrical/plumbing risers, or other uses as necessary (refer to Base Building Plans and Specifications for locations). Mechanical: A VAV heating, ventilating, and air conditioning system for an open floor plan is provided to each floor, with main duct runs, VAV boxes, duct connections from the main duct run to each VAV box and window slot diffusers. VAV boxes are sized to handle loads serving one person per 200 square feet of rentable area and a lighting electrical load of 2.0 watts per square foot of rentable area (subject to Building standard lighting). Plumbing: There will be water and wastewater risers installed for tenant use throughout the Base Building (refer to Base Building Plans for locations). Drinking fountains will be provided in a common area adjacent to restrooms. Doors: Doors and door hardware for doors that are visible from public spaces shall be provided in accordance with the specifications contained in the Base Building Plans. Electrical: Panels will be provided throughout the Base Building sized to handle normal occupant loads. Convenience outlet electrical capacity shall be 4.5 watts per square foot of rentable area demand load and 7.0 watts per square foot of rentable area connected load. One electrical room will be provided on each floor. Communications: One communications closet will be installed on each floor for telephone service. 2 39 Emergency System: The Base Building emergency lighting and fire alarm system will be provided. Tenant will be responsible for code compliant life safety system in Tenant Improvements. Sprinklers: A code compliant sprinkler system will be installed in the Base Building. Modifications to the base system shall be charged at the marginal increased cost of installation as part of Tenant Improvements and shall be required to meet all codes. Structural: The Base Building is designed for a nominal live load of 50 psf along the Base Building perimeter and a nominal live load of 80 psf in the Base Building interior. Elevators: Two passenger elevators will be provided and finished. Signage: Signage will be provided to comply with life safety code requirements. Window Wall: Window blinds in Landlord selected color at each exterior window. Public Restroom: Complete men's and women's restroom facilities are provided on each floor. All restrooms meet current ADA requirements. The Base Building Plans shall be determinative of all issues related to the Base Building. 2. Tenant Improvements. Prior to the Commencement Date, Landlord shall, at its sole cost and expense (except as limited below), construct the improvements desired by Tenant to complete the Building for Tenant's occupancy (the "Tenant Improvements") in accordance with the Drawings (as defined below). The cost of the Tenant Improvements shall be advanced by Landlord for the benefit of Tenant, to be repaid by Tenant in the form of Base Rent, but only to the extent that the aggregate cost of furnishing the Tenant Improvements does not exceed $18.00 per rentable square foot contained in the Premises (the "Tenant Improvement Allowance"). The Tenant Improvement Allowance shall be in addition to the Base Building (as defined below). The following items will be charged against the Tenant Improvement Allowance: (i) architectural, engineering, design and space planning work in preparation of the Drawings necessary to construct the Tenant Improvements, including all mechanical, structural, electrical, plumbing and fire sprinkler engineering required to develop Tenant Improvements or any modifications to the Base Building or Building Standard requested by Tenant and approved by Landlord to accommodate the Tenant Improvements; (ii) the total cost of the Tenant Improvements, (iii) a charge of five percent (5%) of the total costs and expenses otherwise chargeable for the Tenant Improvements for Landlord's construction management of the Tenant 3 40 Improvements (which construction management fee is payable to Landlord in lieu of overhead or other administrative fees of Landlord itself and is exclusive of and in addition to the general contractor's overhead and profit); (iv) Tenant's moving costs; and (v) all other costs and expenses related to the design or construction of the Tenant Improvements (collectively, the "Tenant Improvements Cost"). Landlord shall keep accurate books and records related to the Tenant Improvements Cost. Except as provided in Paragraph 6 of this Exhibit "C" below, the Tenant Improvements Cost in excess of the Tenant Improvement Allowance shall be paid by Tenant prior to Tenant's occupancy of the Premises. 3. Building Standard. For purposes of this Lease, "Building Standard" shall mean those improvements and other items as reasonably approved by Landlord or Landlord's architect as standard for build out purposes of the Tenant Improvements. The improvements set forth as Building Standard are part of the Tenant Improvements and shall be charged against the Tenant Improvement Allowance. The following shall apply unless otherwise specified in this Lease: a. Ceiling System: 2' X 4' suspended lay-in acoustical ceiling. b. Flooring: Building standard flooring will be 32 ounce carpet glued directly to the concrete slab. c. Hardware: Polished finish Yale locksets. d. Interior Doors: Solid core nine foot (9') wood veneer doors with hollow metal frame and latch set. e. Lighting: 2' X 4' parabolic lay-in fluorescent light fixtures 4. Drawings. Tenant's architect, Whitney, Inc., in consultation with Landlord's architect, Graeber, Simmons and Cowan, as design professionals, will prepare the plans, specifications and architectural working drawing for the Tenant Improvements (the "Drawings"). Landlord shall have the right to reasonably approve the Drawings. The cost of the Drawings, including costs and expenses of both Tenant's architect and Landlord's architect, are included in the Tenant Improvements Cost and will be applied against the Tenant Improvement Allowance. The Drawings shall include partition and door location drawings, telephone and electric drawings, and ceiling drawings, and include any specifications required by Tenant, including, but not limited to, paint colors, finish details, and non-standard construction work to be performed within the Premises by the general contractor. Tenant shall cause Tenant's architect to complete the Drawings within the time schedule set forth below. Landlord agrees to promptly respond to Tenant's requests for information and approvals from time to time as necessary to allow the Drawings to be completed by Tenant's architect in a timely manner. 4 41 5. Schedule. In order for the Leased Premises to be substantially completed by the estimated target date of June 7, 2000, Landlord and Tenant acknowledge and agree that it is imperative that the parties adhere to the following schedule: March 20, 2000 - Drawings, including mechanical, electrical and plumbing plans and specifications, all in a form and content suitable for construction bidding, must be completed, approved by Landlord and Tenant, and delivered to Landlord for distribution to general contractors approved by Landlord and Tenant to obtain bids for the cost of the Tenant Improvements March 23, 2000 - Approved general contractors provide to Landlord and Tenant bids for the construction of the Tenant Improvements based on the Drawings. March 27, 2000 - Tenant approves the final construction budget for the Tenant Improvements and selects a general contractor, reasonably acceptable to Landlord (the "General Contractor") March 30, 2000 - Landlord and General Contractor execute the Construction Contract which contains the final approved construction budget approved by Tenant. April 3, 2000 - Building Permit obtained and construction of Tenant Improvements commences If Tenant does not finally approve the construction budget and select the General Contractor by March 27, 2000, the target date of June 7, 2000 shall be automatically extended for the number of days between June 7, 2000, and the day the Tenant approves the final construction budget and selects the General Contractor. 6. Additional Tenant Improvement Allowance. As set forth in Paragraph 1 of this Exhibit "C" above, the Tenant Improvement Allowance is $18.00 per rentable square foot contained in the Premises. All Tenant Improvements Costs in excess of the Tenant Improvement Allowance shall be paid by Tenant prior to occupancy of the Premises. Notwithstanding the foregoing, if the Tenant Improvements Cost is in excess of the Tenant Improvement Allowance, Landlord agrees to provide an additional allowance not to exceed fifty percent (50%) of the Tenant Improvements Cost in excess of the Tenant Improvement Allowance (the "Additional Tenant Improvement Allowance"); provided, however, the Additional Tenant Improvement Allowance, plus interest thereon at the rate of ten percent (10%) per annum, shall be amortized over the initial Term of the Lease and added to the Base Rent. If Tenant requests the Additional Tenant Improvement Allowance, Tenant shall give Landlord written notice thereof prior to Tenant's occupancy of the Premises. Prior to substantial completion of the Premises, Landlord shall prepare and deliver to Tenant an estimate of the Tenant Improvements Cost in excess of the 5 42 Tenant Improvement Allowance and the Additional Tenant Improvement Allowance (the "Estimated Excess Costs"), and Tenant shall pay the Estimated Excess Costs to Landlord prior to Tenant's occupancy of the Premises. Upon substantial completion of the Tenant Improvements and the issuance of a certificate of occupancy for the Premises by the City of Austin, Landlord shall provide Tenant an accounting of the actual Tenant Improvements Cost, which shall include all costs, expenses and fees related to the design and construction of the Tenant Improvements. If the total Tenant Improvements Cost exceeds the Tenant Improvement Allowance, the Additional Tenant Improvement Allowance, and the Estimated Excess Costs paid by Tenant prior to occupancy, Tenant shall pay to Landlord the excess within thirty (30) days from the date such accounting is delivered to Tenant. If the total Tenant Improvements Cost is less than the Tenant Improvement Allowance, the Additional Tenant Improvement Allowance, and the Estimated Excess Costs paid by Tenant prior to occupancy, Landlord shall refund to Tenant any surplus within thirty (30) days from the date such accounting is delivered to Tenant. Tenant, at its expense, shall have the right to examine all of the books and records of Landlord, the General Contractor, or the architects in order to verify and approve the total Tenant Improvements Cost. Once the Additional Tenant Improvement Allowance is finally determined, Landlord shall calculate the revised Base Rent and give Tenant written notice thereof. 7. General Contractor. Tenant acknowledges that the general contractor constructing the Base Building is Constructors & Associates, Inc. ("Constructors"). In order to maintain and monitor the quality of the building construction, the design intent of the systems, including warranties, guarantees, etc., Landlord has recommended to Tenant that all Tenant Improvements be performed by Constructors. Tenant agrees to use Constructors for the Tenant Improvements if Constructors is competitive in their fees, profit and general conditions; provided, however, Tenant shall have the right to have the Tenant Improvements competitively bid by Constructors and other general contractors. 8. Punch List. "Punch List Items" as used herein shall mean any details of construction, decoration, mechanical and electrical adjustments or other matters, which, in the aggregate, are minor in character, the non-completion of which does not materially interfere with Tenant's use or enjoyment of the Premises. Prior to Tenant's occupancy of the Premises, Landlord and Tenant shall conduct a walk-though of the Premises to agree on cosmetic Punch List Items. Within fifteen (15) days after the date Tenant takes occupancy of the Premises, Tenant shall deliver to Landlord a current list of non-cosmetic Punch List Items for the Premises that Landlord is obligated by the provisions of this Lease to complete. The list of cosmetic Punch List Items and the list of non-cosmetic Punch List Items is herein called the "Punch List". Landlord shall use reasonable efforts to complete all Punch List Items within thirty (30) days after the date the applicable approved Punch List is delivered by Tenant to Landlord. 9. Extra Work. Except as set forth herein, Landlord has no other agreement with Tenant and has no other obligation to do any other work with respect to the Premises. Any other 6 43 work in the Premises that may be permitted by Landlord pursuant to the terms and conditions of this Lease shall be done at Tenant's sole cost and expense and subject to Landlord's reasonable approval. If, after the commencement of construction of the Tenant Improvements, Tenant desires to make changes in the Drawings or desires extra work to be performed not contemplated by the Drawings (the "Extra Work"), Tenant, at Tenant's sole cost and expense, shall submit to Landlord all necessary drawings, plans and specifications (the "Extra Work Drawings") to construct the Extra Work. Landlord shall have the right to reasonably approve the Extra Work Drawings. Landlord shall submit to Tenant written estimates of the cost of Extra Work and any delays to Substantial Completion of the Premises resulting from Extra Work (any delays resulting from Extra Work shall constitute a Tenant Delay as defined in Paragraph 10 below). Landlord's estimate of the cost of the Extra Work shall include a charge of five percent (5%) of the total expenses and costs otherwise chargeable for the Extra Work as Landlord's construction management fee (which fee shall be exclusive of and in addition to the General Contractor's overhead and profit). If Tenant fails to approve Landlord's estimate within three (3) business days from the receipt thereof, then Landlord's estimate shall be deemed disapproved in all respects by Tenant and Landlord shall not be authorized to proceed with such Extra Work. If Tenant timely accepts Landlord's estimate, Tenant agrees to pay 50% of the cost of the Extra Work to Landlord upon acceptance of Landlord's estimate, and the balance of the cost of the Extra Work within ten (10) days of being billed therefor by Landlord. All Extra Work shall be done at Tenant's sole cost and expense and shall not be included in the Additional Tenant Improvement Allowance. Landlord shall not be liable for any damages, nor shall the Commencement Date be delayed, nor any Rent abated, as a result of the construction or performance of any Extra Work or any delay in such construction or performance. 10. Tenant's Right of Entry Prior to Occupancy. Landlord hereby consents to Tenant having access to all or any part of the Premises approximately three (3) weeks prior to the anticipated Commencement Date (the "Early Access Period") for the limited purpose of preparing the Premises for occupancy. Such preparations shall include without limitation the installation of computers (and peripherals), voice and data communication systems, wall and furniture systems, and other office equipment and furnishings, subject however to City of Austin, Texas, temporary certificate of occupancy requirements and provided Tenant has delivered to Landlord evidence of all insurance required to be carried by Tenant under this Lease. Landlord and Tenant agree to mutually and reasonably cooperate with each other during the Early Access Period. Tenant acknowledges and agrees that during the Early Access Period, Landlord may still be in process of completing the Tenant Improvements, including, without limitation, laying carpet. During the Early Access Period, Tenant will use reasonable efforts to accommodate Landlord's completion of the Tenant Improvements. Likewise, Landlord acknowledges and agrees that during the Early Access Period, Tenant will be installing wiring, equipment and furniture and Landlord will use reasonable efforts to accommodate Tenant's pre-occupancy installations during the Early Access Period. Landlord acknowledges that Tenant is not required to pay rent during the Early Access Period. During the Early Access Period, Tenant and Tenant's 7 44 agents may enter the Premises, in mutual cooperation with Landlord, in order that Tenant may do such work as may be required by Tenant to make the Premises ready for Tenant's use and occupancy thereof. Tenant's early entry into the Premises is conditioned upon Tenant and Tenant's agents, contractors, workmen, mechanics, suppliers and invitees, working in harmony and not interfering with Landlord, Landlord's agents and the General Contractor in completing the Tenant Improvements or other tenants and occupants of the Building. If at any time such entry shall cause or threaten to cause such disharmony or interference with the timely completion of the Tenant Improvements, Landlord shall have the right to withdraw Landlord's consent to Tenant's early entry of the Premises upon twenty-four (24) hours written notice to Tenant. Tenant agrees that any such early entry into and occupation of the Premises shall be deemed to be under all of the terms, covenants, conditions and provisions of this Lease except as to the covenant to pay Rent, and further agrees Landlord shall not be liable in any way for any injury, loss or damage that may occur to any of the Tenants Improvements or Tenant's installations made in the Premises or to properties placed therein prior to the Commencement Date, the same being at Tenant's sole risk. Tenant hereby indemnifies, defends and hold harmless Landlord and Landlord's Indemnified Parties against any and all claims, demands, losses, liabilities, costs and expenses (including reasonable attorneys' fees) arising out of or related to Tenant's or Tenant's agents entry of the Premises prior to substantial completion of the Premises to install its equipment and furnishings preparatory to its occupancy of the Premises, or on account of injury to any person whatsoever or damage to any property arising out of, in connection with or in any way relating to Tenant's entry of the Premises prior to substantial completion of the Premises. 11. Tenant Delays. Tenant agrees that for purposes of this Lease, the following shall constitute "Tenant Delays": (a) Tenant fails to timely comply with the dates established in the schedule of dates described in Paragraph 5 hereof, including without limitation, having Tenant's architect timely complete the Drawings; or (b) Tenant's failure to furnish information in accordance herewith or to respond to any written request by Landlord for any approval or information within any time period prescribed, or if no time period is prescribed, then within three (3) days of such written request; or (c) Tenant's insistence on materials, finishes or installations other than Landlord's Building Standard after having first been informed by Landlord in writing at or before the time of delivery to Tenant of final construction pricing for Tenant's approval that such materials, finishes or installations will cause a Tenant Delay; or 8 45 (d) Tenant's causes changes to be made in the Drawings (notwithstanding Landlord's approval of such changes) that reasonably would cause a delay in the completion of the Premises or Tenant causes changes in the Tenant Improvements after commencement of construction of the Tenant Improvements resulting in Extra Work; or (e) Tenant, or any person, firm or corporation employed by Tenant, fails to timely perform or complete any work by Tenant or said person, firm or corporation employed by Tenant (all such work and such persons, firms or corporations being subject to the reasonable approval of Landlord); or (f) Tenant shall have directly, or indirectly through any person, firm or corporation employed by Tenant, interfered with or delayed the work of the General Contractor; or (g) Any request by Tenant that Landlord delay the completion of any of Landlord's work; or (h) Any breach or default by Tenant in the performance of Tenant's obligations under this Lease; or (i) Any delay resulting from Tenant's entry of the Premises prior to its being substantially completed, as described in Paragraph 10 of this Exhibit "C" above. 12. Acceptance of Tenant Improvements. Except for the completion of any Punch List Items, the taking of possession of the Premises by Tenant means that (i) Tenant has conducted its own independent investigation of the Premises and that the Premises are suitable for the purpose for which the same are leased, subject to any latent defect which is not discoverable upon reasonable inspection, and (ii) the Building and each and every part and appurtenance thereof are in good and satisfactory condition, except for any latent defect which is not discoverable upon a reasonable inspection. 13. American's with Disabilities Act. Landlord, at Landlord's expense, shall be responsible to construct the common areas, the building systems, exterior walls and the exterior of the Building in compliance with the Americans with Disabilities Act and the Texas Architectural Barriers Act (collectively, the "Act"). Tenant, as part of the Tenant Improvements and included in the Tenant Improvement Allowance, shall be responsible for construction of the Tenant Improvements in compliance with the Act. Tenant shall be responsible, at Tenant's sole cost and expense, for compliance of the Premises with the Act. Tenant covenants and agrees that all alterations and improvements to the Premises constructed by Tenant, whether prior to or after 9 46 the Commencement Date, shall be constructed in accordance with the Act. Except to the extent Landlord is responsible for compliance with the Act as set forth above, Tenant shall be responsible for any accommodations or alterations which need to be made to the Premises to accommodate its disabled employees or customers. If, subsequent to the Commencement Date, Tenant requests Landlord to perform any alterations, additions or improvements to the Premises, whether by virtue of expansion, extension or otherwise, Tenant agrees to and shall be responsible for all costs and expense incurred in connection with any improvements and alterations necessary to ensure compliance with the Act. INITIALED FOR IDENTIFICATION BY LANDLORD AND TENANT 10 47 EXHIBIT "D" TO LEASE BETWEEN INVESTORS LIFE INSURANCE COMPANY OF NORTH AMERICA, AS LANDLORD, AND eLOYALTY CORPORATION, AS TENANT RENTABLE AREA AND COMMENCEMENT DATE DECLARATION This declaration is executed with respect to that certain Lease Agreement (the "Lease") dated March __, 2000 by and between Investors Life Insurance Company of North America, a Washington corporation ("Landlord"), and eLoyalty Corporation, a Delaware corporation ("Tenant"), covering approximately square feet of rentable area on floors four and five of the Building. Capitalized terms used but not defined herein shall have the meanings given to them in the Lease. By their respective execution below, Landlord and Tenant each hereby stipulates and agrees that: (1) The Commencement Date (as defined in Section 2.02 of the Lease) occurred on _________________, 2000, and the Expiration Date is May 31, 2005. (2) The Premises contain rentable square feet. (3) The Building contains __________ net rentable square feet. (4) Tenant's Percentage Share for purposes of calculating Tenants Percentage Share of Operating Expenses is %. (5) Base Rent is payable in equal monthly installments starting on the Commencement Date as follows: Lease Year 1 - $ ($18.50 per rentable square foot) ----------------------------- Lease Year 2 - $ ($19.00 per rentable square foot) ----------------------------- Lease Year 3 - $ ($19.50 per rentable square foot) ----------------------------- Lease Year 4 - $ ($20.00 per rentable square foot) ----------------------------- Lease Year 5 - $ ($20.50 per rentable square foot) -----------------------------
Additional Rent for the calendar year 2000 (based on $8.00 per rentable square foot) is $ per month. 11 48 (6) Other than latent defects of which Tenant is not aware, all construction work per the Drawings is complete with the exceptions outlined in the attached "punch list". Landlord agrees to remedy the items on the punch list within thirty (30) days of the date hereof. This declaration may be relied upon by any person having or acquiring an interest in the Lease or the Building, without notice to or consent of Landlord or Tenant. EXECUTED on this day of , 2000. LANDLORD: INVESTORS LIFE INSURANCE COMPANY OF NORTH AMERICA By: Name: Title: TENANT: eLOYALTY CORPORATION By: Name: Title: 2 49 INITIALED FOR IDENTIFICATION BY LANDLORD AND TENANT 3 50 EXHIBIT "E" TO LEASE BETWEEN INVESTORS LIFE INSURANCE COMPANY OF NORTH AMERICA, AS LANDLORD, AND eLOYALTY CORPORATION, AS TENANT RENEWAL OPTION Provided that a Default by Tenant has not occurred and is continuing, Tenant shall have the right and option (the "Renewal Option") to renew and extend this Lease with respect to all of the Premises for two (2) consecutive renewal terms for respective periods of five (5) years each. In order to exercise each Renewal Option, Tenant must give Landlord written notice of the exercise of the Renewal Option no later than one (1) year prior to the expiration of the initial Term, or the expiration of the first renewal term, as the case may be. Failure by Tenant to notify Landlord in writing of Tenant's election to exercise a Renewal Option herein granted within the time limits set forth for such exercise shall constitute a waiver of such Renewal Option. Each renewal term shall be upon the same provisions as for the initial Term except as follows: 1. In the event Tenant elects to exercise the Renewal Options as set forth above, Landlord shall, within thirty (30) days thereafter, notify Tenant in writing of the proposed rental for the applicable Renewal Term, including any annual adjustments to the Base Rent (the "Proposed Renewal Rental"). Within fifteen (15) days following Landlord's delivery of the Proposed Renewal Rental, Tenant shall notify Landlord in writing of the acceptance or rejection of the Proposed Renewal Rental. If Tenant accepts Landlord's proposal, then the Proposed Renewal Rental shall be the rental rate in effect during the applicable renewal term. If Tenant fails to respond within such fifteen (15) day period, Tenant shall be deemed to have rejected Landlord's Proposed Renewal Rental. If Tenant rejects Landlord's Proposed Renewal Rental during such fifteen (15) day period, Tenant's rejection notice must either (i) withdraw its exercise of the Renewal Option, or (ii) exercise its right to a thirty (30) day negotiation period with Landlord which right is hereby granted. If Tenant exercises such right, Tenant and Landlord shall, in good faith, endeavor to negotiate a reasonable renewal rental rate (the "Negotiated Renewal Rate"), providing supporting cost and market data for its respective renewal rate preferences. If Tenant and Landlord fail to agree upon a Negotiated Renewal Rental during such thirty (30) day period, Tenant's may elect to either (i) withdraw its exercise of the Renewal Option, or (ii) exercise its right to enter into arbitration with Landlord concerning the Market Rate (as hereinafter defined), which right is hereby granted, in accordance with the following procedure. a. Within ten (10) days after Tenant delivers to Landlord its rejection notice requesting arbitration of the Market Rate (the "Designation Date"), Landlord and Tenant shall 4 51 each appoint an independent arbitrator who shall be an appraiser or licensed real estate broker with at least five (5) years experience in building leasing, management and marketing in the Austin, Texas, geographic real estate market or in appraising leasehold interests under commercial leases, and shall be familiar with the valuation of comparable property in such area and otherwise qualified to act as an expert witness over objection to give opinion testimony addressed to the issue in a court of competent jurisdiction. Each independent appraiser shall not have been employed, regularly or as a broker or consultant, during the past six (6) month period by the respective party selecting such person. By the Designation Date, each party shall notify the other party in writing of the name, address, telephone number and qualifications of its appraiser so appointed. If either party shall fail to notify the other party of its named appraiser by the Designation Date, the determination of the Market Rate by the single appraiser appointed shall be conclusive and binding upon both Landlord and Tenant. If both parties timely designate their respective appraisers, then the two appointed appraisers shall select a third qualified appraiser within ten (10) days after the Designation Date. Landlord and Tenant shall each bear the cost of its appraiser and one-half (1/2) of the cost of the third appraiser. b. The three appraisers shall determine the Market Rate in accordance with the parameters set forth herein by mutual agreement within thirty (30) business days after the Designation Date. If all of the appraisers fail to agree on the Market Rate within thirty (30) business days after the Designation Date, but two of the appraisers can so agree, then the Market Rate as determined by such two appraisers shall be controlling. If none of the appraisers can agree on the Market Rate within such time period, then an average shall be taken of the two closest determinations thereof and such average shall be controlling (except that if the median of the three rates provided by the appraisers is also the average of the three, it shall be controlling). Tenant shall have fifteen (15) days to accept or reject in writing the Market Rate as determined by the arbitration procedure. If Tenant does not accept the Market Rate as determined by the arbitration procedure on or before the end of said fifteen (15) day period, then Tenant shall pay all of Landlord's costs associated with obtaining the aforementioned appraisals and Tenant shall be deemed to withdraw its exercise of the Renewal Option, and all rights of Landlord and Tenant under this option to renew shall immediately terminate and all terms and conditions of this option to renew shall be of no further force and effect. Except as noted above in case of a failure to agree on Market Rate, Tenant may not revoke its election to renew after such election has been made. c. For purposes of this Lease and the arbitration process set forth above, "Market Rate" shall be the then prevailing annual rental rates then being charged for comparable space in first class buildings similarly situated to the Building located in Austin, Travis County, Texas, taking into consideration without limitation use, location and/or floor level within the applicable building, definition of net rentable area, leasehold improvements provided, quality, age and location of the applicable building, area of premises, percentage of building included in 2 52 area of premises, rental concessions, the time the particular rate under consideration became effective and all other then prevailing market inducements. 2. During each such renewal term, Tenant shall pay all other Rent and other amounts due under this Lease, including without limitation all rental adjustments pursuant to Article 3 of this Lease, provided that any expense caps or similar limitations shall not be renewed or carried forward (i.e., they shall be adjusted to market) unless the Market Rate contemplates that such limitations be continued during each renewal term. 3. Tenant shall have no further right to renew this Lease. 4. Upon exercise of the Renewal Option by Tenant and subject to the conditions set forth herein, the Lease shall be extended for the period of such Renewal Term without the necessity of the execution of any further instrument or document, although if requested by either party, Landlord and Tenant shall enter into a written agreement modifying and supplementing the Lease in accordance with the provisions hereof. Any termination of the Lease during the initial Term or the first renewal term shall terminate all subsequent renewal rights hereunder. The renewal rights of Tenant hereunder shall not be severable from the Lease, nor may such rights be assigned or otherwise conveyed in connection with any permitted assignment of the Lease, unless such assignment is to Tenant's subsidiary, affiliate, or successor in accordance with the provisions of Article 12. Landlord's consent to any assignment of the Lease to a party other than a subsidiary, affiliate, or successor of Tenant shall not be construed as allowing an assignment of such rights to any assignee. 3 53 INITIALED FOR IDENTIFICATION BY LANDLORD AND TENANT 4 54 EXHIBIT "F" TO LEASE BETWEEN INVESTORS LIFE INSURANCE COMPANY OF NORTH AMERICA, AS LANDLORD, AND eLOYALTY CORPORATION, AS TENANT RIGHT OF FIRST REFUSAL Landlord hereby grants to Tenant a right of first refusal (the "Right of First Refusal") exercisable as hereinafter set forth, covering the remainder of the third floor of the Building, containing approximately 16,414 rentable square feet, more particularly described on the floor plan of the third floor of the Building attached as Exhibit "A" to this Lease (the "Refusal Space"). All rights of Tenant to lease the Refusal Space pursuant to the Right of First Refusal shall be applicable to the entire Refusal Space or to any portion thereof which may become available. The Right of First Refusal shall be as follows: (a) Upon the issuance by Landlord of a formal proposal to a third party tenant to lease all or any portion of the Refusal Space, Landlord shall notify the Tenant in writing (the "Offer Notice") of the issuance of such formal proposal for all or such portion of the Refusal Space (the "Offered Refusal Space"). Tenant may exercise the Right of First Refusal and include the Offered Refusal Space, or any other unleased portion of the Refusal Space under this Lease, upon the terms and conditions of this Lease by delivering to Landlord written notice of Tenant's election (the "Acceptance Notice") on or before the seventh (7th) business day after the date of Tenant's receipt of the Offer Notice. (b) In the event Landlord does not receive Tenant's Acceptance Notice as to the Offered Refusal Space as described in the Offer Notice within said seven (7) business day period, then Landlord shall be free to lease the Offered Refusal Space to one or more third parties, provided such third parties have been the subject of an Offer Notice. Until May 31, 2003 (the "Evergreen Period"), Tenant's failure to give Landlord a Tenant's Acceptance Notice as to any Offered Refusal Space described in an Offer Notice shall not constitute a waiver of Tenant's right to receive a subsequent Offer Notice for all or any portion of such Offered Refusal Space (assuming Landlord does not consummate a lease with such third party tenant the subject of the original Offer Notice). However, on May 31, 2003 the Evergreen Period expires, and thereafter, if Tenant fails to timely give Landlord a Tenant's Acceptance Notice as to any Offered Refusal Space covered by an Offer Notice, then such failure shall be deemed a waiver and 5 55 release of Tenant's Right of First Refusal as to the Offered Refusal Space designated in the Offer Notice. (c) All Refusal Space leased by Tenant pursuant to the Right of First Refusal shall be for a term which is coterminous with the initial Term and any renewal or extension thereof. (d) The term Premises, as used in this Lease, shall include all expansions thereof that may occur from time to time pursuant to this Right of First Refusal. (e) In the event Tenant exercises the Right of First Refusal pursuant to the terms hereof, Landlord shall do the work necessary to furnish and install within the Refusal Space leased by Tenant, in accordance with drawings to be prepared by Tenant and approved in writing by Landlord, the tenant improvements provided for in the drawings. The cost of the work shall be advanced by Landlord for the benefit of Tenant, to be repaid by Tenant in the form of Base Rent, but only to the extent that the aggregate cost of the tenant improvements for the Refusal Space provided for in the drawings does not exceed an amount per square foot leased, rounded up or down to the nearest cent (but not to exceed $18.00), equal to (X) $18.00, times (Y) the number of months remaining in the Term (excluding all renewals, unless such renewals have been irrevocably exercised by Tenant), divided by (Z) sixty (60). (f) The Base Rent for the Refusal Space shall be the same as the Base Rent for the Premises and shall be due and payable commencing on the earlier of (i) the date the tenant improvements constructed by Landlord in the Refusal Space leased by Tenant are substantially completed, or would have been substantially completed but for Tenant Delays, and Landlord has notified Tenant of such completion, or (ii) the date Tenant begins the occupancy of all or any part of the Refusal Space leased by Tenant in a reasonably normal manner for the conduct of Tenant's business. (g) Upon the exercise of the Refusal Option pursuant to the terms hereof, Landlord and Tenant shall execute, at the request of either party, an instrument delineating and describing the any Refusal Space leased by Tenant and thereby added to the Premises. (h) In the event Tenant exercises the Right of First Refusal pursuant to the terms hereof, as a condition precedent to Tenant exercising the Right of First Refusal, Tenant must cause the Security Deposit to be increased to an amount equal to one 2 56 month's Base Rent on the entire Premises, including any Refusal Space leased by Tenant. INITIALED FOR IDENTIFICATION BY LANDLORD AND TENANT 3 57 EXHIBIT "G" TO LEASE BETWEEN INVESTORS LIFE INSURANCE COMPANY OF NORTH AMERICA, AS LANDLORD, AND eLOYALTY CORPORATION, AS TENANT EXPANSION OPTION Subject to the terms and conditions of this Lease, Landlord hereby grants to Tenant an expansion option (the "Expansion Option") exercisable as hereinafter set forth, covering the remainder of the third floor of the Building, containing approximately 16,414 rentable square feet (the "Expansion Space"). (a) Until November 1, 2002, so long as Tenant is not in default in the performance of its covenants under this Lease, Tenant may exercise the Expansion Option to include under this Lease, beginning on June 1, 2003, all or any part of Expansion Space. In the event Tenant desires to exercise the Expansion Option, Tenant must deliver to Landlord written notice (the "Expansion Notice") of Tenant's election on or before November 1, 2002. If Tenant fails to deliver the Expansion Notice to Landlord by November 1, 2002, Tenant's option to expand the Premises as set forth herein shall terminate and be of no further force or effect. The Rent for the Remaining Expansion Space shall the same as for the Rent for the original Premises. (b) If prior to November 1, 2002, Tenant fails to exercise its Right of First Refusal with respect to an Offer Notice for all or any portion of the Offered Refusal Space in accordance with Exhibit "F" and Landlord subsequently leases such Offered Refusal Space to another tenant which has been the subject of the Offered Notice, then Tenant's Expansion Option with respect to such Offered Refusal Space as such space also constitutes Expansion Space, shall terminate; but in such event, Landlord agrees to make available to Tenant up to 16,414 rentable square feet, either in the Building or in other buildings located in the Project as designated by Landlord, as replacement Expansion Space. (For example, and by way of example only, if, prior to November 1, 2002, Landlord gives Tenant an Offer Notice for 5,000 rentable square feet on the third floor of the Building in accordance with Exhibit "F", and Tenant fails to exercise its Right of First Refusal for such 5,000 rentable square feet, and Landlord leases such 5,000 rentable square feet to a third party tenant, then such 5,000 rentable square feet shall also be excluded from the Expansion Space, but only if Landlord makes available to Tenant as replacement Expansion Space 5,000 rentable square feet on 4 58 either the first or second floor of the Building or in another building in the Project reasonably acceptable to Tenant. Tenant's right to expand into the remaining portion of the Expansion Space on the third floor shall not be affected by Tenant's waiver of its Right of First Refusal as to the 5,000 rentable square feet in this example.) (c) If Tenant does not exercise its Expansion Option as to all of the Expansion Space by November 1, 2002, then as to the portion of the Expansion Space which Tenant does not elect to expand, Landlord shall have the right to lease such space to third parties, but subject to the Right of First Refusal set forth in Exhibit "F". (d) The term "Premises," as used in this Lease, shall include all expansions thereof that may occur from time to time. (e) In the event Tenant exercises the Expansion Option pursuant to the terms hereof, Landlord shall do the work necessary to furnish and install within the Expansion Space tenant improvements in accordance with drawings to be prepared by Tenant and approved in writing by Landlord. The cost of the work shall be advanced by Landlord for the benefit of Tenant, to be repaid by Tenant in the form of Base Rent, but only to the extent that the aggregate cost of furnishing the Building Standard improvements and such additional improvements provided for in the drawings does not exceed an amount per square foot leased, rounded up or down to the nearest cent (but not to exceed $18.00), equal to (X) $18.00, times (Y) the number of months remaining in the Term (excluding all renewals, unless such renewals have been irrevocably exercised by Tenant), divided by (Z) sixty (60). (f) The failure by Tenant to timely give the written Expansion Option Notice above shall constitute the Tenant's decision not to exercise the Expansion Option, and the Tenant shall be considered to have permanently waived any rights to the Expansion Space, except for Tenant's Right of First Refusal set forth in Exhibit "F". (f) Upon the exercise of the Expansion Option pursuant to the terms hereof, Landlord and Tenant shall execute, at the request of either party, an instrument delineating and describing the space added to the Premises. (g) All Expansion Space leased pursuant to this Exhibit "G" shall be for a term which is coterminous with the initial Term of this Lease, and any renewal or extension thereof. 2 59 (h) If Tenant timely exercises the Expansion Option and Landlord is unable to accommodate Tenant's expansion needs because of (i) the unavailability of 16,414 rentable square feet of Expansion Space or (ii) in the event Tenant exercised its Right of First Refusal to less than the entire Expansion Space, the unavailability of such amount of space in the Building or the Project as designated by Landlord, in Landlord's discretion, that equals the excess of 16,414 rentable square feet of space less any amount of space obtained by Tenant through its Right of First Refusal and that is reasonably acceptable to Tenant, then Tenant shall have the right to cancel and terminate this Lease as of May 31, 2003, by giving Landlord written notice of such election no later than December 1, 2002; provided, however, as a condition precedent to Tenant being entitled to cancel and terminate this Lease, Tenant must pay, prior to May 31, 2003, liquidated damages to Landlord equal to the unamortized costs incurred by Landlord in connection with this Lease, including, but not limited to, Tenant Improvements constructed by Landlord, Additional Tenant Improvements constructed by Landlord, and leasing commissions. Landlord and Tenant hereby acknowledge and agree they have included the provision for payment of liquidated damages in this Exhibit "G" because, in the event of a termination by Tenant in accordance with this provision, the actual damages incurred by Landlord can reasonably be expected to approximate the amount of liquidated damages called for in this Section (h) of this Exhibit "G", and because the actual amount of such damages would be difficult if not impossible to accurately measure. (i) In the event Tenant exercises the Expansion Option pursuant to the terms hereof, as a condition precedent to Tenant exercising the Expansion Option, Tenant must cause the Security Deposit to be increased to an amount equal to one month's Base Rent on the entire Premises, including any Expansion Space leased by Tenant. 3 60 INITIALED FOR IDENTIFICATION BY LANDLORD AND TENANT 4 61 EXHIBIT "H" TO LEASE BETWEEN INVESTORS LIFE INSURANCE COMPANY OF NORTH AMERICA AS LANDLORD AND eLOYALTY CORPORATION, AS TENANT CERTIFICATE OF THE SECRETARY The undersigned, Secretary of eLoyalty Corporation, a Delaware corporation (the"Corporation"), hereby certifies that attached is a true and correct copy of the resolutions duly adopted by unanimous consent dated , 2000, of all directors of the Board of Directors of the Corporation and that the same have not been amended, altered or rescinded and are now in full force and effect; that the Corporation is duly organized and existing under the laws of the State of Delaware; that all franchise and other taxes, if any, required to maintain the corporate existence of the Corporation have been paid when due and that no such taxes are delinquent; that no proceedings are pending for the forfeiture of the Certificate of Incorporation of the Corporation or for its dissolution, voluntary or involuntary; that the Corporation is duly qualified to do business in the State of Texas and is in good standing in such state; that there is no provision of the Articles of Incorporation or Bylaws of the Corporation limiting the powers of the Board of Directors to pass or consent to the resolutions set out in the instrument attached hereto and that said resolutions are in conformity with the provisions of said Articles of Incorporation and Bylaws; and that the Secretary is the keeper of the records and minutes of the proceedings of the Board of Directors of the Corporation. This is to further certify that the persons named below are the duly elected and qualified officers of the Corporation, holding the respective offices set forth opposite their names, that they continue to hold these offices at the present time, and that the respective signatures set opposite their names are the genuine, original signatures of each respectively: Name Title Signature President ---------------------------- ------------ Secretary ---------------------------- This is to further certify that the Corporation is duly organized and existing under the laws of the State of Delaware; that all franchise and other taxes, if any, required to maintain the existence of the Corporation have been paid when due and that no such taxes are delinquent; that no proceedings are pending for the dissolution or liquidation of the Corporation, voluntary 5 62 or involuntary; that the Partnership is duly qualified to do business in the State of Texas; and that there is no provision of the partnership agreement establishing the Corporation which would limit the powers of the Corporation to execute a lease pursuant to the provisions which are attached hereto. IN WITNESS WHEREOF I have hereunto affixed my name as Secretary and have caused the corporate seal of the Corporation to be hereto affixed this day of , 2000. Secretary The undersigned, , President of the Corporation, hereby certifies that , is the duly elected and qualified Secretary of the Corporation, that the signature above is his (her) genuine signature, that attached is a true and correct copy of the resolutions duly adopted by the Board of Directors of the Corporation, which are now in full force and effect; and that the foregoing certificate is true and correct. President [ATTACHED TO THIS CERTIFICATE MUST BE CORPORATE RESOLUTIONS EVIDENCING THAT THE OFFICER EXECUTING THE LEASE HAS AUTHORITY TO EXECUTE THIS LEASE FOR TENANT] 2 63 INITIALED FOR IDENTIFICATION BY LANDLORD AND TENANT EXHIBIT "I" TO LEASE BETWEEN INVESTORS LIFE INSURANCE COMPANY OF NORTH AMERICA AS LANDLORD AND eLOYALTY CORPORATION, AS TENANT RULES AND REGULATIONS The following standards shall be observed by Tenant for the mutual safety, cleanliness and convenience of all occupants of the Building. These rules are subject to change from time to time, as specified in the Lease. 1. Tenant shall not use the Premises or the Building to sell any items or services at retail price or cost without the prior written consent of Landlord. Stenography, typewriting, blueprinting, duplicating services of any kind, food and beverage services, and similar businesses, shall not be conducted from or within the Premises or Building for the service or accommodation of other occupants of the Building without the prior written consent of Landlord. 2. Sidewalks, halls, passageways, fire exits, roof access, and stairwells shall not be obstructed or used by Tenant for a purpose other than ingress and egress to and from the Premises and Building. 3. Flammable, explosive or other hazardous liquids and materials shall not be brought on the Premises or into the Building without the prior written consent of Landlord. All holiday decorations shall be made of flame retardant materials and are limited to the interior of the Building. 4. All contractors and technicians performing work for Tenant within the Building shall be referred to Landlord for approval before performing such work. All work, including, but not limited to, installation of telephone and telegraph equipment, electrical and electronic 3 64 devices and attachments, and all installations affecting floors, walls, windows, doors, ceilings or any other physical feature of the Building, shall not commence prior to written approval by Landlord. 5. Tenant shall not conduct any auction on the Premises nor store goods, wares or merchandise on the Premises, except for Tenant's own personal use. 6. Movement into or out of the Building of freight, furniture, office equipment or other material for dispatch or receipt by Tenant which requires movement through public corridors or lobbies or entrances to the Building shall be limited to the use of elevators only and shall be done at hours and in a manner approved by Landlord for such purposes from time to time. Only licensed, commercial movers shall be used for the purpose of moving freight, furniture or office equipment to and from the Premises and Building. All hand trucks shall be equipped with rubber tires and rubber side guards. 7. Requests by Tenant for building services, maintenance or repair shall be made in writing to the office of the Landlord or its management agent, if any. 8. Tenant shall not change locks or install additional locks on doors without prior written consent of Landlord. Tenant shall not make or cause to be made duplicates of keys procured from Landlord without the prior approval of Landlord. All keys to the Premises shall be surrendered to Landlord upon termination of tenancy. 9. Tenant shall give prompt notice to the office of the Landlord or its management agent, if any, of any damage to or defects in plumbing, electrical fixtures or heating and cooling equipment. Liquids, or other materials or substances which will cause injury to the plumbing, shall not be put into the lavatories, water closets or other plumbing fixtures, by Tenant, its agents, employees or invitees. 10. Tenant shall not place, install or operate on the Premises, or in any part of the Building or Project, any stoves or cooking equipment outside any kitchen areas without the prior written approval of Landlord. 11. Large files, safes, electronic data processing equipment and other heavy equipment shall not be moved into the Building or installed in the Premises without the prior written approval of Landlord. 12. Tenant shall not lay floor covering within the Premises without the prior written approval of Landlord. The use of cement or other similar adhesive materials not easily removed with water is expressly prohibited. 2 65 13. Tenant agrees to cooperate and assist Landlord in the prevention of canvassing, soliciting and peddling within the Building. 14. Nails, screws or picture hangers shall not be driven into the wood finish of any room without the prior written consent of Landlord. Animals or birds shall not be kept in or about the Premises or the Building. 15. All plants within the Tenant Suite should be maintained by professional plant management companies. Any infestation as a result of the plants is the responsibility of the Tenant. 16. No sign, advertisement, notice or handbill shall be exhibited, distributed, painted or affixed by Tenant which is visible from any part of the Project beyond the boundaries of the Premises without prior written consent of the Landlord. 17. Landlord reserves the right to exclude from the Building, between the hours of 6:00 p.m. and 7:00 a.m. on weekdays and at all hours on Saturday, Sunday and legal holidays, all persons who are not known to the Building watchman, if any, and who do not present a pass to the Building signed by Tenant. Each Tenant shall be responsible for all persons for whom he supplies a pass or key to the Building or Premises. 18. No smoking is allowed inside the Building. Smoking is restricted to the exterior West end of the Building. Tenant shall be responsible for each employee. 19. Tenant will use all caution when driving and parking in the garage. Landlord is NOT responsible for any lost, stolen, or damage done to persons or property of Tenant and/or its employees as result of parking on the Project. Parking around the Building is limited to handicapped and 30-minute visitor parking only. There is no parking on the streets. Violating vehicles will be towed at owner's expense. 20. Tenant shall not use the Building or the Premises to store vehicles, including without limitation boats, trailers, campers, golf carts, motorcycles or automobiles. All vehicles other than automobiles and motorcycles will be towed and stored at the owner's expense and Landlord shall assume no liability therefore, and Tenant waives any claim arising by reason thereof and agrees to hold Landlord harmless from any such claims arising from such towing, storage or removal. Any automobile or motorcycle left on the Premises for more than twenty (20) consecutive days may be towed and stored at the owner's expense and Landlord shall assume no liability therefore and Tenant waives any claim arising by reason thereof and agrees to hold Landlord harmless from any such claims arising from such towing, storage or removal. 66 INITIALED FOR IDENTIFICATION BY LANDLORD AND TENANT EX-10.16 3 EXHIBIT 10.16 1 EXHIBIT 10.16 [BANK OF AMERICA LOGO] BUSINESS LOAN AGREEMENT Bank of America, N.A. This Agreement dated as of March , 2000, is between BANK OF AMERICA, N.A. (the "Bank") and eLOYALTY CORPORATION (the "Borrower"). 1. LINE OF CREDIT AMOUNT AND TERMS 1.1 LINE OF CREDIT AMOUNT. (a) During the availability period described below, the Bank will provide a line of credit to the Borrower. The amount of the line of credit (the "Commitment") is Ten Million Dollars ($10,000,000). (b) This is a revolving line of credit providing for cash advances and letters of credit. During the availability period, the Borrower may repay principal amounts and reborrow them. (c) Each advance will be for at least One Hundred Thousand Dollars ($100,000), or for the amount of the remaining available line of credit, if less. (d) The Borrower agrees not to permit the outstanding principal balance of advances under the line of credit plus the outstanding amounts of any letters of credit, including amounts drawn on letters of credit and not yet reimbursed, to exceed the Commitment. 1.2 AVAILABILITY PERIOD. The line of credit is available between the date of this Agreement and December 30, 2000 (the "Expiration Date") unless the Borrower is in default. 1.3 INTEREST RATE. (a) Unless the Borrower elects the optional interest rate described below, the interest rate is a per annum rate equal to the Reference Rate defined below. (b) The Reference Rate is the rate of interest publicly announced from time to time by the Bank in San Francisco, California, as its Reference Rate. The Reference Rate is set by the Bank based on various factors, including the Bank's costs and desired return, general economic conditions and other factors, and is used as a reference point for pricing some loans. The Bank may price loans to its customers at, above, or below the Reference Rate. Any change in the Reference Rate will take effect at the opening of business on the day specified in the public announcement of a change in the Bank's Reference Rate. 1.4 OPTIONAL INTEREST RATE. Instead of the interest rate based on the Bank's Reference Rate, the Borrower may elect the optional interest rate listed below during interest periods agreed to by the Bank and the Borrower. The optional interest rate shall be subject to the terms and conditions described later in this Agreement. Any principal amount bearing interest at an optional rate under this Agreement is referred to as a "Portion." The following optional interest rate is available: the IBOR Rate plus 0.75 percentage points. 1.5 REPAYMENT TERMS. (a) The Borrower will pay interest on April 30, 2000, and then monthly thereafter until payment in full of any principal outstanding under this line of credit. (b) The Borrower will repay in full all principal and any unpaid interest or other charges outstanding under this line of credit no later than the Expiration Date. 2 1.6 LETTERS OF CREDIT. This line of credit may be used for financing: (i) standby letters of credit with a maximum maturity not to extend more than one year beyond the Expiration Date. (ii) The amount of the letters of credit outstanding at any one time (including amounts drawn on the letters of credit and not yet reimbursed) may not exceed Three Million Dollars ($3,000,000) (the "L/C Sublimit"). The Borrower agrees: (a) any sum drawn under a letter of credit may, at the option of the Bank, be added to the principal amount outstanding under this Agreement. The amount will bear interest and be due as described elsewhere in this Agreement. (b) if there is a default under this Agreement, to immediately prepay and make the Bank whole for any outstanding letters of credit. (c) the issuance of any letter of credit and any amendment to a letter of credit is subject to the Bank's written approval and must be in form and content satisfactory to the Bank and in favor of a beneficiary acceptable to the Bank. (d) to sign the Bank's form Application and Agreement for Standby Letter of Credit. (e) to pay any issuance and/or other fees that the Bank notifies the Borrower will be charged for issuing and processing letters of credit for the Borrower. (f) to allow the Bank to automatically charge its checking account for applicable fees, discounts, and other charges. 2. OPTIONAL INTEREST RATE 2.1 OPTIONAL RATE. The optional interest rate is a rate per year. interest will be paid on the last day of each interest period, and, if the interest period is longer than 90 days, then on the last day of each quarter during the interest period. At the end of any interest period, the interest rate will revert to the rate based on the Reference Rate, unless the Borrower has designated another optional interest rate for the Portion. No Portion will be converted to a different interest rate during the applicable interest period. Upon the occurrence of an event of default under this Agreement, the Bank may terminate the availability of optional interest rates for interest periods commencing after the default occurs. 2.2 IBOR RATE. The election of IBOR Rates shall be subject to the following terms and requirements: (a) The interest period during which the IBOR Rate will be in effect will be no shorter than 30 days and no longer than 180 days. The first day of the interest period must be a Banking Day on which the Bank is also open for business in California and dealing in offshore dollars. The last day of the interest period will be determined by the Bank using the practices of the offshore dollar inter-bank market. (b) Each IBOR Rate Portion will be for an amount not less than the following: (i) for interest periods of 91 days or longer, Five Hundred Thousand Dollars ($500,000). (ii) for interest periods of between 31 and 90 days, One Million Dollars ($1,000,000). (c) The Borrower may not elect an IBOR Rate with respect to any principal amount which is scheduled to be repaid before the last day of the applicable interest period. (d) The "IBOR Rate" means the interest rate determined by the following formula, rounded upward to the nearest 1/100 of one percent. (All amounts in the calculation will be determined by the Bank as of the first day of the interest period.) -2- 3 IBOR Rate = IBOR Base Rate --------------------------- (1.00 - Reserve Percentage) Where, (i) "IBOR Base Rate" means the interest rate at which the Bank's Grand Cayman Branch, Grand Cayman, British West Indies, would offer U.S. dollar deposits for the applicable interest period to other major banks in the offshore dollar inter-bank market. (ii) "Reserve Percentage" means the total of the maximum reserve percentages for determining the reserves to be maintained by member banks of the Federal Reserve System for Eurocurrency Liabilities, as defined in Federal Reserve Board Regulation D, rounded upward to the nearest 1/100 of one percent. The percentage will be expressed as a decimal, and will include, but not be limited to, marginal, emergency, supplemental, special, and other reserve percentages. (e) Each prepayment of an IBOR Rate Portion, whether voluntary, by reason of acceleration or otherwise, will be accompanied by the amount of accrued interest on the amount prepaid, and a prepayment fee as described below. A "prepayment" is a payment of an amount on a date earlier than the scheduled payment date for such amount as required by this Agreement. The prepayment fee shall be equal to the amount (if any) by which: (i) the additional interest which would have been payable during the interest period on the amount prepaid had it not been prepaid, exceeds (ii) the interest which would have been recoverable by the Bank by placing the amount prepaid on deposit in the domestic certificate of deposit market, the eurodollar deposit market, or other appropriate money market selected by the Bank for a period starting on the date on which it was prepaid and ending on the last day of the interest period for such Portion (or the scheduled payment date for the amount prepaid, if earlier). (f) The Bank will have no obligation to accept an election for an IBOR Rate Portion if any of the following described events has occurred and is continuing: (i) Dollar deposits in the principal amount, and for periods equal to the interest period, of an IBOR Rate Portion are not available in the offshore Dollar inter-bank market; or (ii) the IBOR Rate does not accurately reflect the cost of an IBOR Rate Portion. 3. FEES AND EXPENSES 3.1 FEES. (a) LOAN FEE. The Borrower agrees to pay a loan fee in the amount of Twenty Five Thousand Dollars ($25,000). This fee is due on or before the date of this Agreement. (b) UNUSED COMMITMENT FEE. The Borrower agrees to pay a fee on any difference between the Commitment and the amount of credit it actually uses, determined by the weighted average credit outstanding during the specified period. The fee will be calculated at 0.125% per year. The calculation of credit outstanding will include the undrawn amount of letters of credit. This fee is due on March 31, 2000 and on the last day of each quarter thereafter until the expiration of the availability period. 3.2 EXPENSES. The Borrower agrees to reimburse the Bank upon demand, whether or not any loan is made under this Agreement, for: (a) filing, recording and search fees, appraisal fees, title report fees, documentation fees, and other similar fees, costs and expenses incurred by the Bank. -3- 4 (b) any expenses the Bank incurs in the preparation, negotiation and execution of this Agreement and any agreement or instrument required by this Agreement. Expenses include, but are not limited to, reasonable attorneys' fees, including any allocated costs of the Bank's in-house counsel. (c) any stamp or other taxes which may be payable with respect to the execution or delivery of this Agreement and any agreement or instrument required by this Agreement. 4. DISBURSEMENTS, PAYMENTS AND COSTS 4.1 REQUESTS FOR CREDIT. Each request for an extension of credit will be made in writing in a manner acceptable to the Bank, or by another means acceptable to the Bank. 4.2 DISBURSEMENTS AND PAYMENTS. Each disbursement by the Bank will be made in immediately available funds and will be evidenced by records kept by the Bank. In addition, the Bank may, at its discretion, require the Borrower to sign one or more promissory notes. Each payment made by the Borrower will be made without set-off or counterclaim in immediately available funds not later than 2:00 p.m., Chicago time, on the date called for under this Agreement at the Bank's office at 231 South LaSalle Street, Chicago, Illinois 60697. Funds received on any day after such time will be deemed to have been received on the next Banking Day. Whenever any payment to be made under this Agreement is stated to be due on a day which is not a Banking Day, such payment will be made on the next succeeding Banking Day and such extension of time will be included in the computation of any interest. 4.3 TELEPHONE AND FACSIMILE AUTHORIZATION. (a) The Bank may honor telephone or facsimile instructions for advances or repayments or for the designation of optional interest rates and facsimile requests for the issuance of letters of credit given by any one of the individuals authorized to sign loan agreements on behalf of the Borrower, or any other individual designated by any one of such authorized signers. (b) Advances will be deposited in and repayments will be withdrawn from the Borrowers account or such other of the Borrower's accounts with the Bank as designated in writing by the Borrower. (c) Upon the Bank's request, the Borrower will provide written confirmation to the Bank of any telephone or facsimile instructions within 2 days. if there is a discrepancy and the Bank has already acted on the instructions, the telephone or facsimile instructions will prevail over the written confirmation. (d) The Borrower indemnifies and excuses the Bank (including its officers, employees, and agents) from all liability, loss, and costs in connection with any act resulting from telephone or facsimile instructions the Bank reasonably believes are made by any individual authorized by the Borrower to give such instructions. This indemnity and excuse will survive this Agreement. 4.4 DIRECT DEBIT. (a) The Borrower agrees that interest and any fees will be deducted automatically on the due date from the Borrower's checking account number , or such other of the Borrower's accounts with the Bank as designated in writing by the Borrower. (b) The Bank will debit the account on the dates the payments become due. If a due date does not fall on a Banking Day, the Bank will debit the account on the first Banking Day following the due date. (c) The Borrower will maintain sufficient funds in the account on the dates the Bank enters debits authorized by this Agreement. If there are insufficient funds in the account on the date the Bank enters any debit authorized by this Agreement, the debit will be reversed. 4.5 BANKING DAYS. Unless otherwise provided in this Agreement, a "Banking Day" is a day other than a Saturday or a Sunday on which the Bank is open for business in Chicago, Illinois. All payments and disbursements which would be due on a day which is not a Banking Day will be due on the next Banking Day. -4- 5 All payments received on a day which is not a Banking Day will be applied to the credit on the next Banking Day. 4.6 ADDITIONAL COSTS. The Borrower will pay the Bank, on demand, for the Bank's costs or losses arising from any statute or regulation, or any request or requirement of a regulatory agency which is applicable to all national banks or a class of all national banks. The costs and losses will be allocated to the loan in a manner determined by the Bank, using any reasonable method. The costs include the following: (a) any reserve or deposit requirements; and (b) any capital requirements relating to the Bank's assets and commitments for credit. 4.7 INTEREST CALCULATION. Except as otherwise stated in this Agreement, all interest and fees, if any, will be computed on the basis of a 360 day year and the actual number of days elapsed. Installments of principal which are not paid when due under this Agreement shall continue to bear interest until paid. 4.8 DEFAULT RATE. Upon the occurrence and during the continuation of any default under this Agreement, principal amounts outstanding under this Agreement will at the option of the Bank bear interest at a rate which is 2 percentage point(s) higher than the rate of interest otherwise provided under this Agreement. This will not constitute a waiver of any default. 5. CONDITIONS The Bank must receive the following items, in form and content acceptable to the Bank, before it is required to extend any credit to the Borrower under this Agreement: 5.1 AUTHORIZATIONS. Evidence that the execution, delivery and performance by the Borrower (and any guarantor) of this Agreement and any instrument or agreement required under this Agreement have been duly authorized. 5.2 GOVERNING DOCUMENTS. A copy of the Borrower's articles of incorporation. 5.3 INSURANCE. Evidence of insurance coverage, as required in the "Covenants" section of this Agreement. 5.4 GUARANTY. A continuing guaranty signed by Technology Solutions Company (the "Guarantor"). 5.5 PAYMENT OF FEES. Payment of all accrued and unpaid expenses incurred by the Bank as required by the paragraph entitled "Expenses". 5.6 GOOD STANDING. Certificates of good standing for the Borrower and the Guarantor from their state of formation and from any other state in which they are required to qualify to conduct their business. 5.7 OTHER ITEMS. Any other items that the Bank reasonably requires. 6. REPRESENTATIONS AND WARRANTIES When the Borrower signs this Agreement, and until the Bank is repaid in full, the Borrower makes the following representations and warranties. Each request for an extension of credit constitutes a renewed representation. 6.1 ORGANIZATION OF BORROWER. The Borrower is a corporation duly formed and existing under the laws of the state where organized. 6.2 AUTHORIZATION. This Agreement, and any instrument or agreement required hereunder, are within the Borrower's powers, have been duly authorized, and do not conflict with any of its organizational papers. -5- 6 6.3 ENFORCEABLE AGREEMENT. This Agreement is a legal, valid and binding agreement of the Borrower, enforceable against the Borrower in accordance with its terms, and any instrument or agreement required hereunder, when executed and delivered, will be similarly legal, valid, binding and enforceable. 6.4 GOOD STANDING. In each state in which the Borrower does business, it is properly licensed, in good standing, and, where required, in compliance with fictitious name statutes. 6.5 NO CONFLICTS. This Agreement does not conflict with any law, agreement, or obligation by which the Borrower is bound. 6.6 FINANCIAL INFORMATION. All financial and other information that has been or will be supplied to the Bank, including the Borrower's financial statement dated as of September 30, 1999, and the guarantor's financial statement dated as of September 30, 1999, is: (a) sufficiently complete to give the Bank accurate knowledge of the Borrower's (and any guarantor's) financial condition, including all material contingent liabilities. (b) in compliance with all government regulations that apply. Since the date of the financial statement specified above, there has been no material adverse change in the assets or the financial condition of the Borrower. 6.7 LAWSUITS. There is no lawsuit, tax claim or other dispute pending or threatened against the Borrower, which, if lost, would impair the Borrower's financial condition or ability to repay the loan, except as have been disclosed in writing to the Bank. 6.8 PERMITS, FRANCHISES. The Borrower possesses all permits, memberships, franchises, contracts and licenses required and all trademark rights, trade name rights, patent rights and fictitious name rights necessary to enable it to conduct the business in which it is now engaged. 6.9 OTHER OBLIGATIONS. The Borrower is not in default an any obligation for borrowed money, any purchase money obligation or any other material lease, commitment, contract, instrument or obligation. 6.10 INCOME TAXES. The Borrower has filed all tax returns required to be filed and has paid, or made adequate provisions for the payment of, all taxes due and payable pursuant to such returns and pursuant to any assessments made against it or any of its property. No tax liens have been filed and no material claims are being asserted with respect to any such taxes. The reserves on the books of the Borrower in respect of taxes are adequate. The Borrower is not aware of any proposed assessment or adjustment for additional taxes (or any basis for any such assessment) which might be material to the Borrower. 6.11 NO EVENT OF DEFAULT. There is no event which is, or with notice or lapse of time or both would be, a default under this Agreement. 6.12 INSURANCE. The Borrower has obtained, and maintained in effect, the insurance coverage required in the "Covenants" section of this Agreement. 6.13 ERISA PLANS. (a) Each Plan (other than a multiemployer plan) is in compliance in all material respects with the applicable provisions of ERISA, the Code and other federal or state law. Each Plan has received a favorable determination letter from the IRS and to the best knowledge of the Borrower, nothing has occurred which would cause the loss of such qualification. The Borrower has fulfilled its obligations, if any, under the minimum funding standards of ERISA and the Code with respect to each Plan, and has not incurred any liability with respect to any Plan under Title IV of ERISA. (b) There are no claims, lawsuits or actions (including by any governmental authority), and there has been no prohibited transaction or violation of the fiduciary responsibility rules, with respect to any Plan which has resulted or could reasonably be expected to result in a material adverse effect. -6- 7 (c) With respect to any Plan subject to Title IV of ERISA: (i) No reportable event has occurred under Section 4043(c) of ERISA for which the PBGC requires 30 day notice. (ii) No action by the Borrower or any ERISA Affiliate to terminate or withdraw from any Plan has been taken and no notice of intent to terminate a Plan has been filed under Section 4041 of ERISA. (iii) No termination proceeding has been commenced with respect to a Plan under Section 4042 of ERISA, and no event has occurred or condition exists which might constitute grounds for the commencement of such a proceeding. (d) The following terms have the meanings indicated for purposes of this Agreement: (i) "Code" means the Internal Revenue Code of 1986, as amended from time to time. (ii) "ERISA" means the Employee Retirement Income Security Act of 1974, as amended from time to time. (iii) "ERISA Affiliate" means any trade or business (whether or not incorporated) under common control with the Borrower within the meaning of Section 414(b) or (c) of the Code. (iv) "PBGC" means the Pension Benefit Guaranty Corporation. (v) "Plan" means a pension, profit-sharing, or stock bonus plan intended to qualify under Section 401(a) of the Code, maintained or contributed to by the Borrower or any ERISA Affiliate, including any multiemployer plan within the meaning of Section 4001(a)(3) of ERISA. 6.14 YEAR 2000 COMPLIANCE. The Borrower has conducted a comprehensive review and assessment of the Borrower's computer applications and made inquiry of the Borrower's key suppliers, vendors and customers with respect to the "year 2000 problem" (that is, the inability of computers, as well as embedded microchips in non-computing devices, to be able to properly perform date-sensitive functions after December 31, 1999) and, based on that review and inquiry, the Borrower does not believe the year 2000 problem will result in a material adverse change in the Borrower's business condition (financial or otherwise), operations, properties or prospects, or ability to repay the credit. 7. COVENANTS The Borrower agrees, so long as credit is available under this Agreement and until the Bank is repaid in full: 7.1 USE OF PROCEEDS. To use the proceeds of the credit only for general corporate purposes and issuing letters of credit (up to the L/C Sublimit). 7.2 FINANCIAL INFORMATION. To provide the following financial information and statements in form and content acceptable to the Bank, and such additional information as requested by the Bank from time to time: (a) Within 90 days of the Borrower's fiscal year end, the Borrower's annual financial statements. These financial statements must be audited by a Certified Public Accountant acceptable to the Bank. The statements shall be prepared on a consolidated basis. (b) Within 45 days of the period's end, the Borrower's quarterly financial statements. These financial statements may be Borrower prepared. The statements shall be prepared on a consolidated basis. (c) Within the period(s) provided in (a) and (b) above, a compliance certificate of the Borrower signed by an authorized financial officer of the Borrower setting forth (1) the information and computations (in sufficient detail) to establish that the Borrower is in compliance with all financial covenants at the end of the period -7- 8 covered by the financial statements then being furnished and (ii) whether there existed as of the date of such financial statements and whether there exists as of the date of the certificate, any default under this Agreement and, if any such default exists, specifying the nature thereof and the action the Borrower is taking and proposes to take with respect thereto. 7.3 TANGIBLE NET WORTH. To maintain on a consolidated basis tangible net worth equal to at least the greater of the following: (a) Seventy Million Dollars ($70,000,000); or (b) 75% of closing Tangible Net Worth measured quarterly. "Tangible Net Worth" means the gross book value of the Borrower's assets (excluding goodwill, patents, trademarks, trade names, organization expense, treasury stock, unamortized debt discount and expense, capitalized or deferred research and development costs, deferred marketing expenses, deferred receivables, and other like intangibles, and monies due from affiliates, officers, directors, employees, or shareholders, of the Borrower) plus liabilities subordinated to the Bank in a manner acceptable to the Bank (using the Bank's standard form) less total liabilities, including but not limited to accrued and deferred income taxes, and any reserves against assets. 7.4 OTHER DEBTS. Not to have outstanding or incur any direct or contingent liabilities or lease obligations (other than those to the Bank), or become liable for the liabilities of others without the Bank's written consent. This does not prohibit: (a) Acquiring goods, supplies, or merchandise on normal trade credit. (b) Endorsing negotiable instruments received in the usual course of business. 7.5 OTHER LIENS. Not to create, assume, or allow any security interest or lien (including judicial liens) on property the Borrower now or later owns, except: (a) Mortgages, deeds of trust and security agreements in favor of the Bank. (b) Liens for taxes not yet due. 7.6 LEASES. Not to permit the aggregate payments due in any fiscal year under all leases (including capital and operating leases for real or personal property) to exceed Ten Million Dollars ($10,000,000). 7.7 LOANS AND INVESTMENTS. Not to make any extensions of credit, or make any investments in, or make any capital contributions or other transfers of assets to, any individual or entity, except the following: (a) extensions of credit in the nature of accounts receivable or notes receivable arising from the sale or lease of goods or services in the ordinary course of business. (b) investments in any of the following: (i) U.S. treasury bills and other obligations of the federal government; (ii) stock of its subsidiaries. (c) investments in venture capital funds, with others, created to invest in companies in loyalty technology, provided, however, such investment capital must come from the proceeds of a secondary public offering. 7.8 NOTICES TO BANK. To promptly notify the Bank in writing of: (a) any lawsuit over Ten Million Dollars ($10,000,000) against the Borrower. -8- 9 (b) any substantial dispute between the Borrower and any government authority. (c) any event of default under this Agreement, or any event which, with notice or lapse of time or both, would constitute an event of default. (d) any material adverse change in the Borrower's business condition (financial or otherwise), operations, properties or prospects, or ability to repay the credit. (e) any change in the Borrower's name, legal structure, place of business, or chief executive office if the Borrower has more than one place of business. (f) any actual contingent liabilities of the Borrower, and any such contingent liabilities which are reasonably foreseeable, where such liabilities are in excess of Five Million Dollars ($5,000,000) in the aggregate. 7.9 BOOKS AND RECORDS. To maintain adequate books and records, 7.10 AUDITS. To allow the Bank and its agents to inspect the Borrower's properties and examine, audit and make copies of books and records at any reasonable time. If any of the Borrower's properties, books or records are in the possession of a third party, the Borrower authorizes that third party to permit the Bank or its agents to have access to perform inspections or audits and to respond to the Bank's requests for information concerning such properties, books and records. 7.11 COMPLIANCE WITH LAWS. To comply with the laws (including any fictitious name statute), regulations, and orders of any government body with authority over the Borrower's business. 7.12 PRESERVATION OF RIGHTS. To maintain and preserve all rights, privileges, and franchises the Borrower now has. 7.13 MAINTENANCE OF PROPERTIES. To make any repairs, renewals, or replacements to keep the Borrower's properties in good working condition. 7.14 PERFECTION OF LIENS. To help the Bank perfect and protect its security interests and liens, and reimburse it for related costs it incurs to protect its security interests and liens. 7.15 COOPERATION. To take any action reasonably requested by the Bank to carry out the intent of this Agreement. 7.16 INSURANCE. (a) GENERAL BUSINESS INSURANCE. To maintain insurance as is usual for the business it is in. (b) EVIDENCE OF INSURANCE. Upon the request of the Bank, to deliver to the Bank a copy of each insurance policy, or, if permitted by the Bank, a certificate of insurance listing all insurance in force. 7.17 ADDITIONAL NEGATIVE COVENANTS. Not to, without the Bank's written consent: (a) engage in any business activities substantially different from the Borrower's present business. (b) liquidate or dissolve the Borrower's business. (c) enter into any consolidation, merger, pool, joint venture, syndicate, or other combination, or become a partner in a partnership, a member of a joint venture, or a member of a limited liability company. (d) sell, assign, lease, transfer or otherwise dispose of any assets for less than fair market value, or enter into any agreement to do so. (e) enter into any sale and leaseback agreement covering any of its fixed or capital assets. -9- 10 (f) acquire or purchase a business or its assets. (g) voluntarily suspend its business for more than 7 days in any 30 day period. 7.18 BANK AS PRINCIPAL DEPOSITORY. To maintain the Bank as its principal depository bank, including for the maintenance of business, cash management, operating and administrative deposit accounts. 7.19 ERISA PLANS. With respect to a Plan subject to Title IV of ERISA, to give prompt written notice to the Bank of: (a) The occurrence of any reportable event under Section 4043(c) of ERISA for which the PBGC requires 30 day notice. (b) Any action by the Borrower or any ERISA Affiliate to terminate or withdraw from a Plan or the filing of any notice of intent to terminate under Section 4041 of ERISA. (c) The commencement of any proceeding with respect to a Plan under Section 4042 of ERISA. 8. DEFAULT If any of the following events occurs, the Bank may do one or more of the following: declare the Borrower in default, stop making any additional credit available to the Borrower, and require the Borrower to repay its entire debt immediately and without prior notice. If an event of default occurs under the paragraph entitled "Bankruptcy" below, with respect to the Borrower, then the entire debt outstanding under this Agreement will automatically be due immediately. 8.1 FAILURE TO PAY. The Borrower fails to make a payment under this Agreement when due. 8.2 FALSE INFORMATION. The Borrower has given the Bank false or misleading information or representations. 8.3 BANKRUPTCY. The Borrower files a bankruptcy petition, a bankruptcy petition is filed against the Borrower, or the Borrower makes a general assignment for the benefit of creditors. 8.4 RECEIVERS; TERMINATION. A receiver or similar official is appointed for the Borrower's business, or the business is terminated, or any guarantor is liquidated or dissolved. 8.5 LAWSUITS. Any lawsuit or lawsuits are filed on behalf of one or more trade creditors against the Borrower in an aggregate amount of Ten Million Dollars ($10,000,000) or more in excess of any insurance coverage. 8.8 JUDGMENTS. Any judgments or arbitration awards are entered against the Borrower, or the Borrower enters into any settlement agreements with respect to any litigation or arbitration, in an aggregate amount of Ten Million Dollars ($10,000,000) or more in excess of any insurance coverage. 8.7 GOVERNMENT ACTION. Any government authority takes action that the Bank believes materially adversely affects the Borrower's financial condition or ability to repay. 8.8 MATERIAL ADVERSE CHANGE. A material adverse change occurs in the Borrower's business condition (financial or otherwise), operations, properties or prospects, or ability to repay the credit. 8.9 CROSS-DEFAULT. Any default occurs under any agreement in connection with any credit the Borrower or any of the Borrower's related entities or affiliates has obtained from anyone else or which the Borrower or any of the Borrower's related entities or affiliates has guaranteed if the default consists of failing to make a payment when due or gives the other lender the right to accelerate the obligation. 8.10 DEFAULT UNDER RELATED DOCUMENTS. Any guaranty, subordination agreement, security agreement, mortgage, deed of trust, or other document required by this Agreement is violated or no longer in effect. -10- 11 8.11 OTHER BANK AGREEMENTS. The Borrower fails to meet the conditions of, or fails to perform any obligation under any other agreement the Borrower has with the Bank or any affiliate of the Bank, or demand is made by the Bank or any affiliate of the Bank on any obligation owing to the Bank or such affiliate under any other agreement the Borrower has with the Bank or any affiliate of the Bank. 8.12 ERISA PLANS. The occurrence of any one or more of the following events with respect to a Plan subject to Title IV of ERISA, provided such event or events could reasonably be expected, in the judgment of the Bank, to subject the Borrower to any tax, penalty or liability (or any combination of the foregoing) which, in the aggregate, could have a material adverse effect on the financial condition of the Borrower: (a) A reportable event shall occur under Section 4043(c) of ERISA with respect to a Plan. (b) Any Plan termination (or commencement of proceedings to terminate a Plan) or the full or partial withdrawal from a Plan by the Borrower or any ERISA Affiliate. 8.13 OTHER BREACH UNDER AGREEMENT. The Borrower fails to meet the conditions of, or fails to perform any obligation under, any term of this Agreement not specifically referred to in this Article. This includes any failure or anticipated failure by the Borrower to comply with any financial covenants set forth in this Agreement, whether such failure is evidenced by financial statements delivered to the Bank or is otherwise known to the Borrower or the Bank. 9. ENFORCING THIS AGREEMENT; MISCELLANEOUS 9.1 GAAP. Except as otherwise stated in this Agreement, all financial information provided to the Bank and all financial covenants will be made under generally accepted accounting principles, consistently applied. 9.2 ILLINOIS LAW. THIS AGREEMENT IS GOVERNED BY THE INTERNAL LAWS OF THE STATE OF ILLINOIS. 9.3 SUCCESSORS AND ASSIGNS. This Agreement is binding on the Borrower's and the Bank's successors and assignees. The Borrower agrees that it may not assign this Agreement without the Bank's prior consent. The Bank may sell participations in or assign this loan, and may exchange financial information about the Borrower with actual or potential participants or assignees; provided that such actual or potential participants or assignees agree to treat all financial information exchanged as confidential. 9.4 SEVERABILITY; WAIVERS. If any part of this Agreement is not enforceable, the rest of the Agreement may be enforced. The Bank retains all rights, even if it makes a loan after default. If the Bank waives a default, it may enforce a later default. Any consent or waiver under this Agreement must be in writing. 9.5 ADMINISTRATION COSTS. The Borrower will pay the Bank for all reasonable costs incurred by the Bank in connection with administering this Agreement. 9.6 ATTORNEYS' FEES. The Borrower shall reimburse the Bank for any reasonable costs and attorneys' fees incurred by the Bank in connection with the enforcement or preservation of any rights or remedies under this Agreement and any other documents executed in connection with this Agreement, and in connection with any amendment, waiver, "workout" or restructuring under this Agreement. In the event of a lawsuit or arbitration proceeding, the prevailing party is entitled to recover costs and reasonable attorneys' fees incurred in connection with the lawsuit or arbitration proceeding, as determined by the court or arbitrator. In the event that any case is commenced by or against the Borrower under the Bankruptcy Code (Title 11, United States Code) or any similar or successor statute, the Bank is entitled to recover costs and reasonable attorneys' fees incurred by the Bank related to the preservation, protection, or enforcement of any rights of the Bank in such a case. As used in this paragraph, "attorneys' fees" includes the allocated costs of the Bank's in-house counsel. 9.7 ONE AGREEMENT. This Agreement and any related security or other agreements required by this Agreement, collectively; -11- 12 (a) represent the sum of the understandings and agreements between the Bank and the Borrower concerning this credit; and (b) replace any prior oral or written agreements between the Bank and the Borrower concerning this credit; and (c) are intended by the Bank and the Borrower as the final, complete and exclusive statement of the terms agreed to by them. In the event of any conflict between this Agreement and any other agreements required by this Agreement, this Agreement will prevail. 9.8 INDEMNIFICATION. The Borrower will indemnify and hold the Bank harmless from any loss, liability, damages, judgments, and costs of any kind relating to or arising directly or indirectly out of (a) this Agreement or any document required hereunder, (b) any credit extended or committed by the Bank to the Borrower hereunder, and (c) any litigation or proceeding related to or arising out of this Agreement, any such document, or any such credit. This indemnity includes but is not limited to attorneys' fees (including the allocated cost of in-house counsel). This indemnity extends to the Bank, its parent, subsidiaries and all of their directors, officers, employees, agents, successors, attorneys, and assigns. This indemnity will survive repayment of the Borrower's obligations to the Bank. All sums due to the Bank hereunder shall be obligations of the Borrower, due and payable immediately without demand. 9.9 NOTICES. All notices required under this Agreement will be in writing and will be transmitted by personal delivery, first class mail, overnight courier, or facsimile to the addresses or facsimile numbers on the signature page of this Agreement, or to such other addresses or facsimile numbers as the Bank and the Borrower may specify from time to time in writing. 9.10 HEADINGS. Article and paragraph headings are for reference only and do not affect the interpretation or meaning of any provisions of this Agreement. 9.11 COUNTERPARTS. This Agreement may be executed in as many counterparts as necessary or convenient, and by the different parties on separate counterparts each of which, when so executed, will be deemed an original but all such counterparts will constitute but one and the same agreement. 9.12 CONSENT TO JURISDICTION. To induce the Bank to accept this Agreement, the Borrower irrevocably agrees that, subject to the Bank's sole and absolute election, ALL ACTIONS OR PROCEEDINGS IN ANY WAY ARISING OUT OF OR RELATED TO THIS AGREEMENT WILL BE LITIGATED IN COURTS HAVING SITUS IN CHICAGO, ILLINOIS. THE BORROWER HEREBY CONSENTS AND SUBMITS TO THE JURISDICTION OF ANY COURT LOCATED WITHIN CHICAGO, ILLINOIS, WAIVES PERSONAL SERVICE OF PROCESS UPON THE BORROWER, AND AGREES THAT ALL SUCH SERVICE OF PROCESS MAY BE MADE BY REGISTERED MAIL DIRECTED TO THE BORROWER AT THE ADDRESS STATED ON THE SIGNATURE PAGE HEREOF AND SERVICE SO MADE WILL BE DEEMED TO BE COMPLETED UPON ACTUAL RECEIPT. 9.13 WAIVER OF JURY TRIAL. THE BORROWER AND THE BANK EACH WAIVES ANY RIGHT TO A TRIAL BY JURY IN ANY ACTION OR PROCEEDING TO ENFORCE OR DEFEND ANY RIGHTS (a) UNDER THIS AGREEMENT OR ANY RELATED AGREEMENT OR UNDER ANY AMENDMENT, INSTRUMENT, DOCUMENT OR AGREEMENT DELIVERED OR WHICH MAY IN THE FUTURE BE DELIVERED IN CONNECTION WITH THIS AGREEMENT OR (b) ARISING FROM ANY BANKING RELATIONSHIP EXISTING IN CONNECTION WITH THIS AGREEMENT, AND AGREES THAT ANY SUCH ACTION OR PROCEEDING WILL BE TRIED BEFORE A COURT AND NOT BEFORE A JURY. THE BORROWER AGREES THAT IT WILL NOT ASSERT ANY CLAIM AGAINST THE BANK OR ANY OTHER PERSON INDEMNIFIED UNDER THIS AGREEMENT ON ANY THEORY OF LIABILITY FOR SPECIAL, INDIRECT, CONSEQUENTIAL, INCIDENTAL OR PUNITIVE DAMAGES. -12- 13 This Agreement is executed as of the date stated at the top of the first page. BANK OF AMERICA, N.A. eLOYALTY CORPORATION By: By: Timothy J. Cunningham ---------------------------- ---------------------------- Title: Title: ------------------------- ------------------------- Address and facsimile number Address and facsimile number where notices to the Bank are where notices to the Borrower to be sent: are to be sent: 231 South LaSalle Street 205 North Michigan Avenue Chicago, Illinois 60697 Chicago, Illinois 60601 Attention: Upper MW Strategies II Attention: Timothy Cunningham FAX: (312) 974-2109 FAX: (312) 228-4501 -13- EX-21.1 4 SUBSIDIARIES 1 EXHIBIT 21.1 ELOYALTY CORPORATION SUBSIDIARIES OF THE COMPANY The following are all the subsidiaries of eLoyalty and were established in connection with eLoyalty being spun-off from Technology Solutions Company effective February 15, 2000. eLoyalty Europe Delaware eLoyalty Limited UK eLoyalty GMBH Germany eLoyalty France SARL France eLoyalty Ltd. Switzerland eLoyalty Pty. Ptd Australia eLoyalty Corporation Canada (Canada) Geising International Ltd. New York EX-23.1 5 CONSENT OF PRICEWATERHOUSECOOPERS LLP 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (No. 333-96473) and (No. 33-30374) of eLoyalty Corporation's of our report dated February 15, 2000 appearing in this eLoyalty Corporation Report on Form 10-K for the year ended December 31, 1999. /s/ PricewaterhouseCoopers LLP March 30, 2000 Chicago, Illinois EX-27 6 FINANCIAL DATA SCHEDULE
5 1,000 YEAR DEC-31-1999 JAN-01-1999 DEC-31-1999 13,462 7,175 46,140 2,084 0 77,915 5,371 3,087 96,603 22,988 0 0 0 414 73,201 96,603 0 146,003 0 137,961 (127) 0 72 8,097 4,039 0 0 0 0 4,058 0.10 0.09
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