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Taking Stock: Tough Times Challenge i2, Spotlight Importance Of Customer Care

Pricing pressure may make i2's fixed-price strategy backfire.

This quarter's earnings season is winding down, thank goodness. The financial news has been mind-numbing, but most investors must be getting different information than I am. That's the only explanation I have for the recent bout of optimism expressed by rising technology share prices.

Let's discuss i2 Technologies Inc. (ITWO-Nasdaq), a leading provider of supply-chain management software. The highly visible Dallas company has been successful during the boom times--that's why I invested in it.

So how is it coping in the downturn? Not well. I2 is well-known for its products for supply-chain management, supplier-relationship management, and customer-relationship management. Product features include procurement, commerce, fulfillment, customer care, planning, and product development.

With the recent launch of i2 5.2, its Web-based product, the company is attempting to move beyond its traditional supply-chain management boundary to include monitoring and execution. Many of the feature sets and products were generated internally, but a lot came by way of acquisitions. Thus, much of its traditional client-server application slate was a hodgepodge of purchased technologies, and the suite wasn't always the easiest to implement. Though the current move to a coordinated, Web-based application is a step in the right direction, customer care wins the big points in a downturn, and I'm not sure i2 has gotten the message.

In an economic downturn, price and short-term return on investment are crucial to any IT manager's business decision. Normally, I'd have guessed that supply-chain management would be high on the project list. However, IT managers have long project lists and more product choices. This undoubtedly results in greater pricing concessions from vendors. Fixed-price contracts in this space, once unheard of, aren't uncommon anymore. Companies such as i2 haven't had to worry about cost overruns in the past; they will now. Pricing pressure will hurt profits, and i2's fixed-price strategy may backfire.

In the latest quarter, i2 cut quota-carrying sales reps, including managers, to 409 from 536 in the previous quarter. Since most of the heads that rolled supposedly came from sales management, I'm assuming that not all the sales managers were let go. The numbers imply a ratio of one manager for every three to four salespeople. Why so much sales management to begin with?

Third-quarter revenue this year was $194 million, resulting in an operating loss of 13 cents per share. Revenue declined about 20% from the second quarter. However, license revenue was only $68 million, down from $106 million. In the most recent quarter, the number of new deals was 55, down from 87 in the previous quarter and 104 in the year-ago quarter. Selling prices continue to decline, too; the average selling price was $909,000, down from $989,000 last quarter. I2 had just 14 $1 million-plus deals in the latest quarter, down from 24 in the previous quarter. Only one deal in the most-recent quarter was worth more than $5 million.

Expense control is imperative. Expenses run more than $280 million--quite a bit more than the revenue line. This was down 12% from last quarter on an operating basis (operating basis excludes the large accounts-receivable write-off), but it's still not down enough to compensate for the decline in revenue or license fees. Management hopes to reduce expenses by 20% over the next three quarters. This will include cutting the payroll (an estimated 1,000 out of the current 5,555 employees), outsourcing, and mandatory furlough programs.

There are 417 million i2 shares outstanding. At the current price of about $4.60, a far cry from the 52-week high of $96, that's an equity market capitalization of nearly $1.9 billion. I2 took a major goodwill write-down of $4.7 billion for its Aspect Development acquisition. Cash declined to $765 million from $819 million in the previous quarter. Despite $1.83 per share in cash value (roughly a third of the share price), I wouldn't buy the stock today. There are too many unanswered operational issues.

William Schaff is chief investment officer at Bay Isle Financial Corp., which manages the InformationWeek 100 Stock Index. Reach him at bschaff@bayisle.com.

To discuss this column with other readers, please visit William Schaff's forum on the Listening Post.

To find out more about William Schaff, please visit his page on the Listening Post.

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