Declaring that "i2 is back," CEO and chairman Michael McGrath told Wall Street analysts late last week that the company's strong fourth-quarter financial results marked the completion of its turnaround, but acknowledged that management still faces challenges in revitalizing overall revenue growth.
For the period ended December 31, the Dallas-based supply chain software vendor reported net earnings of $69.4 million, compared with a loss of $2.1 million in the like period of 2004. Revenue for the quarter was $96.6 million, up 25% from the corresponding quarter the year prior, driven primarily by new software license revenue from recently delivered composite applications that ride on its new web services business process management platform.
"Software solutions" revenue, in fact, jumped 28% from the prior quarter to $23 million, which was 43% higher than the year-earlier period, McGrath told analysts. The rise in new license revenue offset declines in services and maintenance fees, which plunged 7% and 11% from the year-earlier period to $25.4 million and $25 million, respectively.
"Q4 was a great quarter for i2, capping a historic business and financial turnaround that we started at end of Q1 and completed in the last three quarters," McGrath noted during a conference call to discuss the financial results.
Consistent profitability has removed the nagging question of i2's viability, which should position the company to build on its Q4 success and reignite top-line growth, McGrath said. "By end of 2005, we achieved the financial stability that I committed to our customers when I took over as CEO of i2," McGrath said. "We've got three quarters in a row of solid operating profits ... This gives our customers confidence that i2 will be around for a long time and it eliminates what was the most significant sales objection, which was our financial instability."
As evidence of the turnaround, McGrath pointed to the quarter's positive cash flow of $15 million, which he attributed to a restructuring earlier in the year that created vertical business units. "The industry organizations ... kicked into full gear and are managing the scope of operations much better," he declared.
For the year, which got off to a sluggish start, the company reported net earnings $84.3 million, compared with a net loss of $3.1 million the year earlier. Key to the turnaround, McGrath said, was i2's ability to slash quarterly expenses to $80 million by cutting headcount and improving operational efficiencies.
Total revenue for the year was $336.9 million, down 7% from 2004. This figure included approximately $42.5 million in contract revenue (revenue deferred from the company's fiscal 2003 restructuring), compared with nearly twice that in fiscal year 2004. Excluding contract revenue, operating revenue for the year reached $294.4 million, a 1.6% increase from the year-earlier period.
Again, software solutions, including core license and recurring license revenue, as well as fees for developing licensed functionality, offset declines elsewhere. Software revenues hit $89.9 million, up 66% from the prior year. Services and maintenance revenues, however, declined 11% and 14% in 2005 from the year-earlier period, to $103.8 million and $100.6 million, respectively.
Revenues generated by maintenance and services are not expected to reverse course until i2's Agile platform gains additional traction, CFO Mike Berry told analysts during a question and answer session.
A $235 million debt restructuring, which included a $75 million private equity investment as well as the sale of two non-core businesses -- trade services and content management -- helped to bolster the company's books, Berry noted. As of year end, i2 had $117 million in cash and equivalents on its balance sheet, with only $25 million in debt due at end of year. An additional $75 million in debt is due by year-end 2015, he explained.
2005 was a critical year for i2, noted William Brandel, a principal at Industry Directions, a Boston-based industry analyst firm specializing in manufacturing and supply chain automation solutions. i2, he said, had to first prove that its finances were in order; and then, amid a painful structuring and application architectural revamp, sell new software and not just drift into service and maintenance mode.
"They have succeeded on both counts," he said in an e-mail exchange with Managing Automation. "Their finances look stable" and the market has responded positively to that, he said. "The fact that they picked up a sizable chunk of business from ... new composite apps for the Agile platform is a promising sign."
With the restructuring complete, McGrath said the time had come for i2 to turn its attention to revenue growth, an issue that hounds more than a few best-of-breed enterprise software vendors, including supply-chain software arch rival Manugistics. "The priority remains on profitability, but we'll be investing in new [revenue] growth strategies," he said.
McGrath pointed to five areas in which the company will invest during the coming year: operational excellence (extending improvements achieved last year while bolstering service margins and sales efficiencies); increasing market share (amid a mature and fragmented supply-chain software market); extending "thought leadership" by focusing on next-generation products (composite applications that run on its new Agile platform); increasing penetration of its marquee installed base ; and using its Agile platform to expand into market segments that "were not economically possible" without new service-oriented architectures and business process engines.
In fact, McGrath said the company's nine new composite applications launched since September are just now beginning to bear fruit. Approximately 30% of i2's "software solutions" Q4 revenue was derived from "next generation" applications, McGrath said, which was up significantly from the 8% recorded during the previous period.
The question is whether the company's application architectural transformation can help it ward off incursions from both SAP and Oracle, which have serious designs on the supply chain management space. McGrath said i2 has had success by positioning itself as "the supply chain company," which resonates with companies seeking best-of-breed solutions.
The market, he continued, is self-selecting: companies looking for simpler applications are calling SAP, not i2, he said. Companies with more complex needs are finding i2 a willing and able partner, with SAP stepping aside, McGrath contended. "We've competed well against SAP over the last few months," he noted. "We're not seeing Oracle that much."
Although the company is no longer providing quarterly guidance, Berry said it was important that the restructured i2 offer some visibility on what 2006 may bring. He said the company expected revenues to come in equivalent to or slightly above those reported in 2005, with earnings per share of between $1 and $1.25, disregarding how the expensing of stock options will impact the bottom line.
Industry Directions' Brandel said that while i2's 2006 outlook "is somewhat cautionary," the company's realistic approach is necessary amid its continuing business transformation. "Their challenge will be to get customers excited about the use and deployment of composite apps, and to make these their new bread-and-butter products," he said. "It's still new territory, so this will be a challenge. Not insurmountable, but a challenge. However, if they can do that, they're in good shape."
McGrath said the sales pipeline for 2006 looks strong, just one month into the calendar year. "Frequently you come out of the fourth quarter and things look narrow, but our operations people and group leaders now have discipline in how to manage two or three quarters out," he said. "We're not left just with the left-overs" from 2005.