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A Fresh Start for i2

On his 55th birthday about a year ago, Michael McGrath retired as chief executive of Pittiglio Rabin Todd & McGrath, a consulting firm specializing in supply-chain management that he founded some 30 years ago. His intention was to while away the time at his seaside home in Maine, watching the boats drift along the Atlantic Ocean.

That lasted about five months. Now, McGrath is attempting one of the toughest turnarounds in the software industry as the new chief executive of Dallas-based i2 Technologies (ITWO). McGrath passed on the top spot several times but finally agreed to join the board soon after his retirement. After a year of telling the company founder and reluctant CEO Sanjiv Sidhu what he should be doing, the blunt, plain-spoken McGrath weakened. "I could see what was wrong and what could be fixed, and I got dragged into it. I finally had to step forward," he says.

"IT'S AMAZING." Sidhu moved up to chairman of the maker of supply-chain-management software, and McGrath went into Bob Vila mode. For starters, he stopped picking up the tab for cell phones for the entire staff. Then he cut all corporate travel unless it was billable to clients. And he laid off 13% of employees -- most of whom were in upper management. "In the past, layoffs were all done at the worker level. We had way too many VPs and higher-paid executives," says McGrath.

In a little more than a quarter, McGrath has managed to get i2's stock relisted on the Nasdaq, raise nearly $40 million to shore up its balance sheet, and dramatically cut costs -- by $20 million in the second quarter alone. "It's amazing how much one person can do in a little over a quarter," says Pat Walravens, an analyst with JMP Securities, who had never heard of McGrath before he took the job in March. "He said, 'Give me 30 days, and I'll have a plan,' and no one believed him."

They do now. When i2 reported its second quarter on July 29, sales were $98 million, down from $110.4 million in the second quarter of 2004, but ahead of what analysts expected. Even better, analysts had been expecting a loss, but McGrath surprised investors with earnings of $31.5 million -- almost triple a year ago. The stock, which had been back on Nasdaq just shy of a month, rose 70% to close at $22.13 after the earnings announcement. And analysts like Walravens and Brad Reback from CIBC World Markets found themselves doing something they likely couldn't imagine months ago: upgrading and recommending the stock.

TWO KEY ASSETS. Indeed, if i2 were a cat, it would have been nearing the end of its ninth life before McGrath came along. Delisted from the Nasdaq, it was on its fifth year of declining revenues, and it was saddled with $300 million in debt. Then the market went south, as spending on supply-chain-management software grew slower than nearly all other business software categories.

Of course, i2's fortunes weren't helped by four years of revenue restatements announced in 2003 and an accompanying investigation by the Securities & Exchange Commission. i2 settled with the SEC last year, paying a $10 million fine and admitting to no wrongdoing.

As dire as that all seemed at the time, McGrath says i2 had two key things to build on: solid technology and a customer base that includes big names in tech and retail like Dell (DELL), Payless Shoe Source (PSS), and Nokia (NOK). New customers have been hard to come by, but many existing ones have stuck by i2, re-signing deals in recent years even as the company faced major problems. "That's surprising from the outside, but if you talk to their customers it's not," says Kevin O'Marah, analyst at AMR Research. "Their core products are really fantastic, and everyone forgot that."

MOVING MORE SHOES. Some of i2's recent tech improvements have been helping companies predict how different products will sell, in real time and even at the store level. For instance, Payless Shoes used to mark down shoes that weren't selling by 50% to 75% to make room for new styles. The problem was, sometimes shoes that weren't selling well over 4,200 stores, were selling very well in select markets. Nonetheless, managers got the mandate to discount them -- leaving money on the table.

Now, thanks to new i2 software, Payless can look at how things are selling on a store-by-store basis. It saved the retailer $75 million the first time it was used to determine where Payless should discount, McGrath says.

Dell, too, uses i2's technology to match what's selling online with what it has stocked in warehouses. It then automatically changes Web promotions to push products that are already in the pipeline. It can also sync with the manufacturing plant, raising production of a certain line that's selling well. And Dell does this every two hours.

"MISERABLE EXISTENCE." But McGrath isn't just counting on big supply-chain-management packages to boost the top line. He has completely changed how i2 sells software. Under McGrath, salespeople are no longer swinging for the fences. Simply put, he has admitted something analysts have said of struggling business-software companies for years: They can no longer live on big multimillion deals. Because software purchases were so large, companies were dragging their feet.

That meant long, expensive sales cycles. It was costing i2 $1 million to sell $1 million in software, McGrath says. And there was no guarantee when a deal would close, which led to very unpredictable earnings. i2's shaky balance sheet didn't exactly inspire confidence, either.

To get that price point down in the hundreds of thousands per deal, McGrath is selling software in chunks that address specific parts of the manufacturing or fulfillment process. The idea is the lower price point will lead to a shorter sales cycle, and it'll build more trust, bringing the customer back for more chunks of software. "It's a miserable existence," he says of relying on the big deal to save the quarter. "Customers know the game. They'll wait until the end of the quarter and demand a 50% price decrease."

GOOD RIDDANCE. It's a very gutsy move, and one similarly beleaguered software companies have been loath to make. You have to close more deals to make the same amount of money, and the software has to perform as advertised, or customers won't come back. Much of i2's salesforce, which relied on hefty commissions from these deals quit. Many more were fired.

McGrath didn't sweat it -- he'd rather sell through third-party consultants anyway. That lowers the cost of sales even further, he argues. "He's swapping the potential for huge, hockey-stick growth for less volatility," O'Marah says. "But it's probably the most important thing he has done."

It's still a tough road for i2. Supply-chain-management software is set to grow next year, but only by 4%, and strong competitors Oracle (ORCL) and SAP (SAP) are gobbling up market share. McGrath, who says he's just an interim CEO, will have to keep up the bold moves if he wants to get back to Maine before the next hot Texas summer. By Sarah Lacy in Silicon Valley

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