Extreme makeover

GTSI shakes off its reseller roots, sees future as solutions provider

"Today the whole world is giving us credit. We don't owe the banks anything other than that subordinated debt, which we will retire at the end of this year." ? Jim Leto, GTSI

Following two years of declining sales and multimillion dollar losses in 2005 and 2006, GTSI Corp. is holding fast in 2007 to the wide-ranging recovery and restructuring plan begun 18 months ago.

GTSI last week reported $153.6 million in sales for the second quarter of fiscal 2007, an increase from $144.1 million in the first quarter. Still, that was less than the $181 million in sales the second quarter of fiscal 2006. Professional services accounted for $21.7 million in the second quarter of 2007 compared to $15.6 million for the second quarter of 2006.

The company had a net loss of $3.6 million in the second quarter compared to the first-quarter loss of $6.9 million. GTSI had net income of $944,000 for the same period in 2006.

"I am delighted with the progress that we have made to date," said Jim Leto, GTSI president and chief executive officer in announcing the quarterly results Aug. 14. "Our attrition is down, our operating expenses are currently running well below budget. Our [sales] margin is well above budget, and our booked sales right now are significantly over budget, so it portends great things for both the third quarter and the fourth quarter. We are well on our way to achieving profitability in 2007."

GTSI stock fell slightly to $10.70 a share following the earnings announcement, down from $11.17 a share Aug. 13.

When Leto became president and CEO early in 2006, the company was in the throes of a mid-decade decline, the result of the confluence of several negatives. In 2005, the company had a net loss of $16 million on total revenue of $886.3 million compared to net income of $10.3 million on revenue of almost $1.1 billion in 2004.

Much of that loss was because of changes in how the government bought goods and services, a poorly operating new enterprise resource planning system, a bloated sales department, and revenue and expense imbalances resulting from weaker sales and higher workforce-related costs.

So Leto altered GTSI's course from its traditional reseller role to that of a customer-focused solutions provider. Since then, the company has dropped low-margin sales of information technology products in favor of more lucrative IT solutions, reduced its sales staff and fixed an ineffective distribution system that had amassed a backlog of 10,000 orders.

The fiscal situation reached critical mass when GTSI's bankers issued a notice of financial default, putting the company on the verge of bankruptcy, and Ernst and Young gave GTSI a rating "of concern."

"By the end of May [2006], most of our creditors denied us credit and put us on credit hold," Leto said. "It was pretty dire."

A forbearance agreement by the banks forestalled bankruptcy and allowed GTSI to arrange a new credit agreement worth $135 million, $10 million worth of subordinated debt "and a host of covenants that were really onerous," Leto said. "We really had no choice at the time but to enter into an agreement that pinned us down on a whole bunch of details."

GTSI later paid between $250,000 and $500,000 in default fees on the covenants, Leto said, part of the price of doing business to get the company fiscally sound again.

"Today the whole world is giving us credit," which he estimated to be worth between $280 million and $300 million. "We don't owe the banks anything other than that subordinated debt, which we will retire at the end of this year."

Leto said GTSI broke its solutions business into five areas: physical security, mobile evidence capture, unified communications, network security, and server and storage consolidation.

The company moved its largely unprofitable small-order business from the sales staff to the company's Web site. "We stopped discounting on all small orders," Leto said.

The company also added overnight delivery as an incentive for customers to order via the Internet. He said profit margins increased almost immediately. "We ended the year at 13.2 percent gross margin, the highest gross margin at year-end in the company's history."

In addition, GTSI unveiled Technology Lifecycle Manage- ment, "where we sell a solution to a customer, and we wrap it with professional services and financial services," Leto said.

GTSI introduced a touchless order system last month that will process orders for technology products that do not require customization without interaction from GTSI employees. The company has 12 Web-based portals that are customized for either a client or a specific contract.

Professional services, which generate 25 percent to 30 percent of the company's gross margin, tripled from $18 million to $54 million, he said. GTSI also built a $300 million financial services portfolio.

A broad, new human-capital management plan has reduced annual employee attrition from 55 percent to about 15 percent.

"In November of last year," Leto said, "we hit an all-time low of somewhere around 6 percent annualized attrition, which is almost unheard of."

By instituting a hiring freeze and eliminating some $20 million in operating expenses, GTSI decreased its monthly expenses to $8.2 million.

"Companywide online training has made a significant difference in the operating efficiency," Leto said, "which is evident by the fact that we're running at 87 percent required due date ? that's [delivery] compliance on all of our contracts, which is significant."

Perhaps even more significant, GTSI has won a place on government contracts worth more than $60 billion.

They include the Army Information Technology Solu- tions Enterprise 2 Hardware contract, NASA Solutions for Enterprisewide Procurement award, the Homeland Security Department's First Source contract, and a subcontracting role on the General Services Administration's Networx Uni- versal and Enterprise telecommunications contracts.

In addition, the company has racked up $100 million in IT sales to state and local governments, particularly first-responder security services, through the U.S. Communities contract, said Scott Friedlander, executive vice president at GTSI. "We've moved to an infrastructure solutions and services capability."
"The management in its first year has done a tremendous job of improving the business and the health of the business as well," said Brian Kinstlinger, an analyst at small-cap equity research firm Sidoti and Co., of New York. "I think the story has been improving every quarter."

Kinstlinger said GTSI services bookings have been extremely strong. "The more they can get services involved with the business, the more profitable the company can become."

He predicted the company would reach profitability in the second half of the year.
"What I think you will see in the second half of the year," Kinstlinger said, "is not only will they be profitable, but for the year the numbers will be profitable as well. That will more than offset the losses in the first half of the year, which hasn't been the case in recent history."

But GTSI's new business model has not yet made a believer out of Scott Lewis, president and CEO of PS Partnerships LLC, a consulting company in Falls Church, Va. "As a true systems integrator solutions provider in the way that I define it, I don't think they're there at all," he said.

Lewis, a former group publisher of Washington Technology and Government Computer News, said he does not think building data storage systems, for example, makes GTSI a solutions provider.

"Leto is probably doing a good job as far as turning them around and making them profitable," he said. "But in my mind, they really haven't become a true solutions provider in the large scale of things like solving business problems ? for example, improving claims processing."

Leto said he would take the remarks as a compliment. "Have you ever gone into a data center?" he asked. "They're very complex, very sophisticated. They have pipes going in and going out. They have wireless connections, routers and storage devices. They consolidate storage, they have software ? and if they [all] don't work in harmony, it doesn't work."

Meanwhile, Leto is seeking new ways to grow GTSI, notably through acquisitions. He said he is looking at one company in particular that provides managed services, leasing and storage, and storage consolidation solutions. Without giving away any specifics, he said, "They're right in our sweet spot."

Associate Editor David Hubler can be reached at dhubler@1105govinfo.com.

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