Capitol Cancellation

PC Connection learned that lesson recently when the General Services Administration (GSA) took the drastic step of canceling the solution provider's contract because of incorrect procedures. PC Connection announced in November that a GSA review of its subsidiary, GovConnection, found that the company's contract-management systems and procedures "may have resulted in the sale of unqualified items or the underpayment of required fees."

GovConnection's GSA contract, which dates back to 1997, is valued at approximately $56 million in revenue and $4.8 million in gross profits for the first nine months of this year, according to the company. As a result of the cancellation, the company is anticipating sales to decline sequentially in the low 20-percent range for GovConnection's fourth-quarter results.

During a press conference following the announcement, PC Connection CEO Patricia Gallup said PC Connection had launched an internal investigation with an independent auditing firm. "We have no indication of intentional wrongdoing," she said. "This action grew out of a routine GSA audit and was not in reaction to a single event."

As a result of the cancellation, PC Connection announced that GovConnection CEO Gary Sorkin has been placed on a leave of absence and replaced by Don Weatherson. Sorkin founded the government solution provider ComTeq Federal in 1993, which was purchased by PC Connection in 1999 and later renamed GovConnection.

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Weatherson, a former U.S. Naval officer, served as vice president of North America operations and strategy at HP-Compaq before joining GovConnection's board of directors earlier this year. "We are cooperating fully with the GSA," Weatherson said during the conference call. "The company has been open and forthcoming in its dealings with the government, and will continue to do so."

Following this review, GovConnection intends to implement appropriate changes and submit an application for a new agreement with the GSA, which could be approved within a few months, Gallup and Weatherson said. Weatherson said the two issues in question--unpaid fees and the sale of unauthorized goods--are related but that the contract's problems may go back prior to PC Connection's acquisition of ComTeq Federal in 1999. Thus, the problems may have existed before the subsidiary was under PC Connection's control. In addition, Weatherson said the movement of authorized products on and off the GSA Schedule is "very volatile."

Weatherson also said the audit that led to the cancellation has been in effect for about two years and was the first such audit of the contract since it was awarded six years ago. He said the prolonged nature of the investigation may have been one of the aspects that led to the GSA's drastic action against PC Connection. "One of the factors that we face is that there's been a long period of time without resolution, which caused the GSA to cancel the contract," Weatherson said.

At the Raymond James IT Supply Chain conference in New York last month, at which PC Connection was a presenter, Mark Gavin, senior vice president of finance and CFO of PC Connection, gave an update on the situation. "We have had very good meetings with the GSA since we've lost the contract. I can tell you they're going out of their way and being very helpful in trying to get the contract back to us," Gavin said.

Federal officials are working with PC Connection to resubmit its GSA application, Gavin said, and the company expects the contract will be returned by February. Gavin also said the solution provider has benefited from the timing of the contract cancellation, which has occurred in the slowest seasonal period for government business.

But along with the revenue loss and image hit, PC Connection also found itself in an embarrassing situation with its creditors. Shortly before the Raymond James conference, the company announced that its lenders affirmed PC Connection's $45 million line of credit and key inventory purchase security agreements; the lenders granted the solution provider a waiver for the technical default resulting from the loss of the GSA contract. PC Connection emphasized that it carries no long-term debt and that its balance sheet is sound.

"Contrary to the impression made by news reports published last week, PC Connection did not miss any payments to creditors," Gavin said in a prepared statement. "However, we were in technical default due to the GovConnection GSA contract matter until the waivers were granted."

To be sure, the solution provider's business is still quite healthy; PC Connection saw steady growth in net sales over 2003. Still, the episode illustrates just how devastating the loss of one GSA contract can be, and how even simple procedural errors in contract management can put a solution provider in the hole.

Red Tape
The cancellation of a GSA contract is somewhat rare. While there are numerous laws and conditions for delivering IT solutions to the federal government, selling non-GSA-authorized products and other violations aren't uncommon practices. Many solution providers say that government oversight of the GSA is lax--the agency doesn't audit contracts annually--and the regulations are porous.

However, Washington has been cracking down on government contracts this year; the U.S. Attorney's Office, the Justice Department and the General Accounting Office (GAO) of Congress have been investigating allegations of fraud surrounding government contracts designated for small businesses through the Small Business Administration (SBA). (See "Size Does Matter" in the March 31 GovernmentVAR supplement.) After receiving numerous complaints from solution providers and advocacies such as the Microcomputer Industry Suppliers Association (MISA), based in Novato, Calif., the agencies began looking into instances where large corporations, such as Verizon and AT&T Wireless, were winning deals earmarked specifically for small businesses.

Earlier this year, the GAO reported that nearly 10 percent of the companies that won federal contracts designated for small businesses in fiscal 2001 were in fact large corporations. In particular, five large enterprises received $460 million in small-business awards, according to the report.

Still, not many companies have been penalized or had their contracts revoked. MISA president Lloyd Chapman is doubtful that much progress will be made on that issue, as federal agencies have been slow to act. "Resellers are learning more and more about the fraud and abuse, and a lot of people are unhappy," Chapman says.

To put the blame entirely on big corporations and solution providers like PC Connection would be an inaccurate portrayal of the situation. The federal government has had its own problems recently; the GAO report cited errors made by contracting officials.

The federal government's contracting practices have come under fire this year regarding a scandal involving the indictment of two former high-level Pentagon officials. Robert Neal Jr., director of the office of Small and Disadvantaged Business Utilization with the Department of Defense (DoD), and Francis Jones, Neal's executive assistant and a former GSA official, were indicted last year on charges that they extorted money and accepted bribes from companies doing business with the DoD and GSA.

As for PC Connection, the cancellation won't scare the company away from the federal government market. Gallup said the company is committed to getting the contract back, and Gavin said talks with the GSA are moving in the right direction. "They really haven't given us a lot of insight into the problem yet, other than they believe we need to enhance our contract-management systems," Gavin said. "But we're aware of what we need to do to get it back, and that's what we're working on."