FBR analyst: i2 Technologies convertible trading rich amid weak results, cash burn, deferred revenues

By Ronda Fears

Nashville, April 23 - With i2 Technologies Inc. turning out weak results, burning cash and posting a high level of deferred revenues, Freedman Billings Ramsey bond analyst David Marsh said the internet firm's convertible is trading rather expensive.

"We believe that downside price risk continues to outweigh upside price potential in the convertible notes at current trading levels," Marsh said in a report Friday.

The i2 Tech 5.25% convertible due 2006 was at 84 bid, 85 offered late Friday. The stock ended off 11 cents, or 11%, to 89 cents.

"Based on first quarter results and our projection for the remainder of the year, we now believe that i2 Tech will have negative EBITDA in 2004. Therefore, we find it difficult to value the company as a going concern, given our projection for continued cash burn throughout the remainder of 2004. In addition, we remain highly uncertain regarding the amortization of deferred revenue and the effect that such event will have on the company's liquidity," Marsh said.

"Therefore, we value i2 Tech using a liquidation analysis. Under this scenario, we assume that i2 Tech would be forced to pay all trade claims and accrued liabilities at par before repaying convertible noteholders. In addition, we assume that the company would be forced to return 100% of deferred revenues to its customers, before making a payment to convertible investors.

"Using this methodology, we believe that the convertible notes could be worthless if the company is forced into liquidation."

On Thursday after the market close, i2 Tech reported results that fell significantly shy of analysts' expectations. Also, Marsh said the company's liquidity continues to deteriorate and the timing of a potential return to positive free cash flow remains highly uncertain.

i2 Tech reported first quarter revenues of $83.6 million, which were well shy of his $97.1 million forecast. In addition, negative EBITDA of $19.4 million in first quarter was significantly worse than his breakeven EBITDA projection. The company posted a net loss of $30 million, or 7 cents per diluted share, versus a net loss of $41.3 million, or 9 cents per diluted share, in first quarter 2003.

Cash burn was estimated at $20 million in first quarter as the company showed $289.7 million of cash and liquid investments - a sequential decline of about $20 million. Cash burn could have been slightly higher in the quarter, Marsh said, had it not been for an estimated $5 million in positive net working capital changes.

i2 Tech's balance sheet continues to weaken, the analyst said, noting that against the $289.7 million cash and liquid assets, the company continues to carry a $356.8 million debt balance, which consists mostly of the $350 million convertible.

Key risks include contingent liabilities such as shareholder class action lawsuits, a formal Securities and Exchange Commission investigation, and a high level of deferred revenues.

Deferred revenues are a particular concern, recorded at $216.9 million at March 31, especially for convertible holders in terms of recovery in a default or bankruptcy scenario.

"If we assume that the company can work out a compromise with those customers that account for the deferred revenue on i2 Tech's balance sheet, whereby the company is only forced to return 50 cents on the dollar to these customers, convertible investors could recover between 21 and 25 cents per dollar of par amount of convertible notes owned," Marsh said in the report.

"Regardless of the resolution of the deferred revenue issue, we believe that the convertible notes continue to carry significantly more downside price risk at current trading levels than upside price potential."

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