In Re: i2
The scene: a court of public opinion. The first case on the docket is the public v. i2. The charge: bad behavior, arrogance, irrelevance. The penalty for conviction: death by a thousand cuts.
Opening Statement: the Prosecution
Ladies and gentlemen, you have before you i2, once among the mighty, who squandered its wealth and frittered away the respect it had earned. i2 ipromised growth worthy of a Fedex or a Starbucks; now it has shrunk so far that it is no longer welcome on the NASDAQ. i2 is on its last legs. Its license revenue has fallen to minuscule levels; it is beset with shareholder and customer lawsuits, and at any point, the SEC could charge its management with crimes.
We ask, gentlemen of the jury, only that you look at the plain facts and render the only possible verdict: pariah. Tell the world to look elsewhere for supply chain software, a supply chain partner, or a supply chain company.
Opening Statement of the Defense
Ladies and gentlement, you can fault the i2 of the past, but the company before you is the company that exists today. And that company has a lot going for it: good software, loyal customers, enough cash to act, recent votes of confidence from key customers, a business model that suits its customer needs, a macroeconomic climate that may be favoring it, and the very real prospect of good news in the near future. It is wrong and inappropriate for you to write off a company that is in the process of righting itself.
We are not denying the past. And we acknowledge that more must be done before the past truly lies behind i2. But suits can be settled; investigations ended; the culpable replaced (as in many cases they have been.) Companies are not people; they can be reformed and their assets put once more to good use. This company is in the process of reform; let it go its way and see what it does.
The Charges: Financial Instability
Prosecution. At best, this company's financial
position is unstable. Probably, it's untenable. In the last quarter,
it reported a net loss of $30 million, cash use of $20 million. Yes,
it is $289 million in the bank. But it also
has a note due in December, 2006 of $350 million. To pay it off,
the company should be generating $32 million/quarter in excess cash,
a net improvement of $52 million starting this quarter.
Admittedly, a $100 million cash infusion from existing i2
investor Q Investment, has helped some. The terms (another
convertible note valued at
a $.96/share) are very generous. But one has to wonder:
what does this accomplish.
It's not enough to pay
off the debt. And unless you're lending it out for vigorish,
$100 million can't generate $52 million/quarter.
Defense. The cash infusion is considerably more than $100
million; Sanjiv Sidhu, the founder, is also putting in $20 million
and there is also cash from three big deals that i2 recently signed. (Management
is not disclosing how much, but outside observers say it is substantial.)
No, the cash can't suddenly generate $52 million/quarter. But
it can remove some of the barriers that have driven sales so low.
The fact that investors are willing to put in more money
bolsters the confidence of customers.
The money itself lets i2 invest in re-establishing its position
once the suits and investigation are resolved and helps
i2 repair some of the inevitable damage that the rapid contraction caused.
If sales suddenly improve, it won't be because the $100 million
is drawing vigorish. It will be because it allows i2 to bring its
tremendous assets to the market more effectively.
The prosecution wants the cash flow to improve. Already, it appears that
this quarter will be better, since these substantial deals
have already been announced. Presumably, more will be done
on the expense side, too, but i2 has some ability to mitigate
the damage by exploiting its already substantial Indian capabilities.
The SEC and Shareholder Suits
Prosecution.
Investor confidence! Ha! ITWO has had a dot-suffix after its symbol for
two years. The stock hovers at the one-dollar limit, can't meet
capitalization requirements, has just finished a restatement, is going
through the usual shareholder suits, has a new customer suit
on its hands, and has been the subject of a seemingly endless
SEC investigation of its revenue recognition practices.
The restatement, moreover, effectively acknowledged that
revenue recognition practices were faulty and thus that the
various suits and investigations will end negatively. How
negative will it be? The SEC can level criminal charges.
Defense. In its recent earnings call, i2 signaled that
settlements will come soon and that settlement amounts will
be manageable. Clearly, no one can say with certainty
what the SEC will do (or when). But it does seem reasonable to
believe i2.
To foresee a non-crippling settlement, one that leaves current
management in place and doesn't deplete all the cash, one must
have a theory of what happened that leaves the current management team
with some credibility.
Here is a reasonable story, one that is consistent with the personalities
involved and with publicly available knowledge of the facts. Take
the K-mart situation as an example. (I have no idea whether the SEC
cares about this at all, but I am at least somewhat familiar with
the details.)
K-mart signs a very, very large deal with i2. Its
CEO says that with i2's help, K-mart's entire supply
chain will be modernized and made more competitive. An
army of consultants and programmers sets up shop in Michigan and
begins to write code. Under some interpretations, none of the
revenue should be recognized. But it is consistent with the
known facts to surmise some
was.
How could this happen? i2's standard processes for revenue
recognition were fine: not much
different fron what other companies use today. So either the processes
wasn't followed, or they were followed incorrectly. It is easy
to point the figure at a management that was strongly motivated
to report huge increases in license revenue. But it is probably
just as reasonable to believe that in a company that was growing
by double digits every quarter, there was a certain amount of chaos.
Given what I've seen of the personalities involved, it's not
hard to believe that they would stretch things, but it is hard to
believe that they had a handle on all the details of every deal. This
was not a company run by drill sergeants.
I'm not apologizing for i2. The end result is bad; even
at the time, information was available. As a nation,
we're all trying to understand situations where important
information is known by some people, but it doesn't rise to the top.
There is culpability at the top, surely, and, in i2's case, people
acting apparently without much moral fibre or care.
But that doesn't mean that the actions were criminal.
There is a larger issue, too. I think that i2 was
suffering from a basic misunderstanding of its own business. To
grow as rapidly as i2 wanted--to be as successful at K-mart as it
envisioned--their software
would have had to be far easier to build and install than it has
turned out to be.
When you believe that you and you alone have a pill that cures
cancer, you try to sell it as fast as you can. When it turns out that
the pill helps, but to be successful, the patient must also eat
only healthy foods, get plenty of sleep, and meditate 6 hours a day,
you take a more focused approach to marketing, and you spend more
time with the patient after you've sold the pill.
i2 is on its way to taking just this course of action. It's probably
wrong, though, to fault them for not doing it in 1999 or 2000.
You don't face facts easily when doing so forces you to reevaluate completely.
Best in Breed Doesn't Matter
Prosecution. When i2 was worth a few jillions, people believed that supply
chain software could provide them with a competitive edge. If so,
there was every reason to buy a premium product. Better product, more edge. Even if
a big ERP vendor promised something equivalent sometime soon, people thought, we need to start getting the edge now.
Now, belief in supply chain software has ebbed, and there
are plenty of good-enough products on the market. Most users
of i2 software never really exploited its capabilities. For
them and for new customers, there is no reason to buy anything but the product provided by your ERP vendor.
In any case, the old i2 product has aged; whatever edge it used to have is largely gone.
Defense. Belief has certainly ebbed--and justly.
The first generation of supply chain software didn't do
what was promised. People underutilized all this software because it wasn't
practical to do more.
But a strange thing has happened. While the ERP companies were busy catching up to the first-generation best-in-breed tools, the supply chain vendors were (of
necessity) figuring out how to build the second generation. And they've done so. These tools actually overcome some of the problems that used to make deployment so difficult. So in a very real sense, best-in-breed, far from being irrelevant, is better than ever.
Customers haven't yet figured this out, I admit. Today, most don't know the difference between good and mediocre or don't care. And this is a problem
for the supply chain vendors. But the problem is not what the
prosecution says--that the assets are worthless. The problem
is that the market needs education. It is a problem that can be solved.
Too Many Bridges Burnt
Prosecution.
When you're an aggressive, ambitious
company that's growing too quickly, you're likely
to develop a reputation
for being difficult to deal with. But the reputation
that i2 developed during the go-go year wasn't
just that of a clumsy teenager.
Its aggressiveness, arrogance, and inability to deliver left
a sour taste in the mouth of many a customer,
many a partner, and (certainly) many an investor.
These things live with you. It was partly to
change this reputation that Sanjiv Sidhu hired
Sam Nakane, who was indeed beginning to make a difference.
Given how
much had to be done, Sam's sudden and unexplained disappearance
is a bad sign. Did management say, "Enough already, we have to make money."
Or worse, did they think the problem was solved? We don't know.
But if they did, they were sadly wrong. The loss of Sam is
one more sign that i2's management has permanently lost touch.
Defense. Now the prosecution is resorting to
mud-slinging. Whatever the sins of the past, the essential
question is whether i2 is difficult to deal with now.
It's just possible that Sam left because he wanted to
go back to Japan where, I'm told, he
has become CEO of a software company.
Even if i2 still fails some tests of its ability
to cooperate and partner, it clearly has passed others.
Large, important customers don't sign multi-year deals
with people that they can't get along with. And the idea
that management has lost touch is absurd. Yes, it must
address the problem of its public perception, but at this point,
correcting the
impression may be as much a matter of marketing as it is a
matter of execution.
Closing Argument
Prosecution. A software company
stays alive by selling software licenses. Once
the marketplace loses interest in buying its software,
it is only a matter of time before the company closes its doors.
As far as i2 is concerned, the verdict of the public seems clear;
the problems, the disappointments, the restatements, the suits have
scared off customers. And when that happens, gentlemen of the
jury, you have only one verdict to render.
Defense. The prosecution skirts around two essential
facts. i2 has invested 9 figures in developing a software product
that is second to none in its space. In this space, moreover,
the market of potential users has barely been penetrated.
Those companies that actually use the software consistently
report significant, even transformative changes.
Software companies that close their doors have nothing
useful to sell. That is not i2's problem.
i2's problem is, "How do I get people to buy these
great products and use them effectively?"
With license revenue down to $10 million or so last quarter, it's
pretty clear that they haven't solved it. But it is reasonable to
believe that at least part of this problem is not of i2's making.
In times of economic slowdown, when the focus is on cost cutting,
products that help you use assets more efficiently are not going to
be terribly important. It's only when companies start focusing on the
top line that the perils of having an inefficient supply chain become visible.
It's not a perfect storm, but i2 should soon be benefting from
two other macro trends. For them, structural change in any industry is good.
And in 2004, two of its key industries (electronics and retail), are
changing rapidly.
We agree with the prosecution in one thing; i2 must still do a lot
if it is to reverse the trend. But look at what i2 has already done in the last
two years. It has restated its earnings and restructured its balance sheet,
vastly improved its product, and redeployed large parts of the
company so
that it can be better able to meet its customers needs. What more
must be done? We'll cover that in a later piece.
Outside the Courtroom
TV Reporter. We are standing here outside
the courtroom, waiting for the verdict, and Chet, we
want to tell you about something really remarkable:
the defendant is acting completely normal, just as
if there were no trial at all.
At the i2 user conference,
the customer presentations I saw, Chet, were gritty and
commonsensical; nobody had achieved any miracles with i2.
But as usual, the successes were real.
If "i2 is dead" (as one competitor told me a few months ago,"
the news hasn't gotten out. At this conference, interest among retail
and CPG customers was up. (RFID, I believe, is causing
people to look at their systems.) The Asian presence was
also bigger than in previous years. Flagship customers
like Posco (Korean manufacturer) of course got up and talked,
but so did others.
There weren't many ideas that were new to me. But I did
take another look at one of the key i2 products, the Demand
Manager (which is set to replace Demand Planner). Interesting
piece of work. Still not finished, but enough to get
buyers excited.
Wait a minute, Chet. They're calling us back into the courtroom.
I'll be back with a news flash when we know something definite.
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