Moment of Truth for GTSI

It is often said the true character of a company emerges in times of crisis. By that measure, the moment of truth has arrived for Government Technology Services Inc., the leading reseller of computers to the federal government. Falling profit margins and a flawed inventory system forced the Chantilly, Va.-based company to make painful cuts and branch into new lines of business, such as value-added services and integration.

The company's stock is trading at about half its 52-week high of $13.75, after two straight quarters of disappointing results. Still, GTSI has heard some good news in recent weeks. On Aug. 8, the company received an order of 100,000 computer systems through its Air Force Desktop IV contract, which had just reopened.

On Aug. 15, GTSI also initiated the use of credit card transactions via the Internet on a major NASA contract -- an experiment in electronic commerce that could boost its bottom line and help streamline a ponderous procurement system.

GTSI's third quarter will prove decisive for President and CEO Richard M. Rickenbach and GTSI. Since the third quarter encompasses the end of the government fiscal year, the company and its shareholders expect strong sales totals. They also demand that a new systems integration division show signs of growth, and that Rickenbach implement some of his proposed fiscal belt-tightening.

Such demands are hardly new, as computer resellers everywhere face the same challenges. The company built its $400 million business on fulfilling orders for lower-end hardware and software, but that market has become a commodity business with lower profit margins. So GTSI, like similar companies, can get better and bigger at its core business, branch out into services, or do both. It has chosen to do both, with mixed results.

A key part of GTSI's growth strategy was last year's purchase of Falcon Microsystems, which for years had an exclusive franchise selling Apple Computer gear to the federal government. CEO Rickenbach attributes the firm's nearly three-fold sales increase in General Services Administration Schedule business in the first six months of 1995 over the same period in 1994 to the Falcon purchase, which occurred in August 1994.

However, many industry onlookers question the transaction's value. They think that M. Dendy Young, Landover, Md.-based Falcon's chief, got out of the reseller business at the right time and exacted a high price from GTSI: $16.5 million, plus consulting fees. Who can blame Falcon's founder for selling out? In 1987, his company's profit margins averaged 23 percent, but in 1994, the margins had gone into the single digits.

In 1993, Apple had given GTSI authorization to carry its products on GSA Schedule, where previously Falcon had an exclusive deal to sell Apple in the federal government market. Falcon then had to sell DOS and Windows-based PCs by Compaq, Dell and IBM to develop its business. It also ventured into the resale of more sophisticated and profitable computers using the UNIX operating system. Sales increased to nearly $50 million by 1994 on the strength of these moves, but Falcon had to train employees 5 to 6 hours per week in the new technologies, and profit margins continued to fall.

While Rickenbach has said GTSI wanted to retain many of Falcon's 200-plus employees, some ex-Falcon workers question its commitment to that goal. A small number of Falcon executives accepted moving packages offered by GTSI, although it is true some of the 30 ex-Falcon people now at GTSI have made significant contributions.

Bill Johnson, vice president of purchasing and distribution, wants to transform GTSI's sometimes disastrous inventory system into an efficient one like Falcon's Just In Time system. John Lee serves as director of GTSI On-Line, the successful ordering system that the company updates on a continual basis.

Obviously, GTSI's struggles have prompted some speculation on whether the Falcon buy was a wise move. "I think the acquisition was a good idea, but there was a poor use of resources," says Tico Pujals, CEO of Govern-ment Micro Resources, a competitor. "I would have taken Falcon and turned it into the most powerful [UNIX] solutions provider [to concentrate on providing high-end systems]."

Still, GTSI has its true believers. Analyst Bill Loomis of the Baltimore office of Ferris, Baker, Watts, predicts GTSI will make money in the third and fourth quarters, and net 1996. He points out that shareholders haven't been happy with GTSI's performance under Rickenbach -- at press time, GTSI stock was trading for $6.75 on the NASDAQ, after a 52-week high of $13.75 and a low of $4.

Loomis notes that GTSI has embarked on a project to cut overhead costs. In particular, "[the company wants to] implement a flex force plan, which will allow it to temporarily hire personnel instead of hiring and firing when they have busy seasons." Loomis has confidence that GTSI's strong GSA sales will help it to recover from its current woes despite the fact that profit margins have come down to 3 percent.

Despite Loomis' encouraging prognosis, some predict that the sun will set on Rickenbach, if not GTSI. After an inventory debacle in the fourth quarter of 1994, Frank Slovenec, then-president, was demoted to executive vice president and has since left the firm.

The firm has hired the investment banking firm of Robinson Humphrey to find a buyer. In addition, Rickenbach has lost his chairman of the board title to Lawrence Schoenberg.

In the meantime, GTSI faces an on-going Department of Justice probe into how it handles rebates and market development dollars it receives from vendors whose products it carries on the GSA multiple-award schedule contract. Since GTSI has such razor-thin profit margins, few people think that the Justice Department will find much wrong-doing in the reseller's practices.

Rickenbach points out that GTSI has reduced overhead from 9 percent of sales to 6 percent. In addition, he said that his firm has strengths in volume purchasing, quick shipping and marketing to the federal government. The company wants to bolster its profit margins by doing more consulting and value-added work, on top of the high-volume, low-cost product reselling it now does.

As a result, in the second week of June, Rickenbach created the Integrated Systems Division, a 35-employee unit with a goal of contributing 35 percent to 40 percent of total company revenue. While this value-added services division will see higher profit margins, Rickenbach concedes it will be more difficult to manage.