**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

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**FORM 10-K**

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**ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934**

For the fiscal yearended December 31, 2005

Commission FileNumber:     0-19394

**GTSI Corp.**

(Exact name of registrantas specified in its charter)

| **Delaware**                                                    |   | **54–1248422**                   |
|-----------------------------------------------------------------|--------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
| **3901 Stonecroft Boulevard, Chantilly, VA**                    |   | **20151-1010**                        |
| (Address of principal executive offices)                        |   | (Zip Code)                            |

 

**703–502–2000**(Registrant’s telephonenumber, including area code)

Securities registeredpursuant to section 12(b) of the Act:  None

Securities registeredpursuant to section 12(g) of the Act:  Common Stock, par value$0.005 per share

Indicate by check mark if the registrant is awell-known seasoned issuer as defined in Rule 405 of the Securities Act.    YES   o      NO   þ

Indicate by check mark if the registrant is notrequired to file reports pursuant to Section 13 or Section 15(d) ofthe Act.   YES   o      NO   þ

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.   YES   þ    NO   o

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K. þ

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2of the Exchange Act:

Large acceleratedfiler   o      Acceleratedfiler   þ      Non-acceleratedfiler   o

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Act).    YES   o      NO   þ

The aggregate market value of the voting common equityheld by non-affiliates computed by reference to the price at which the commonequity was last sold, as of June 30, 2005 was $76,211,149.

The number of shares outstanding of the registrant’scommon stock on February 28, 2006 was 9,496,460.

**DOCUMENTS INCORPORATED BY REFERENCE**

Items 10, 11, 12, 13 and 14 of Part III of this Form 10-Kare incorporated by reference to GTSI’s proxy statement to be filed with theSecurities and Exchange Commission in connection with the Annual Meeting ofStockholders scheduled to be held on May 9, 2006.

 

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**CONTENTS**

|               | ** ** | ** **                        | ** ** | ** **                                                                                                         | ** ** | **Page** |
|---------------|------------|-----------------------------------|------------|--------------------------------------------------------------------------------------------------------------------|------------|----------|
| PART I   |       | Item 1.                           |       | Business                                                                                                           |       | 1        |
|          |       | Item  1A.                         |       | Risk Factors                                                                                                       |       | 12       |
|          |       | Item 1B.                          |       | Unresolved Staff Comments                                                                                          |       | 21       |
|          |       | Item 2.                           |       | Properties                                                                                                         |       | 21       |
|          |       | Item  3.                          |       | Legal Proceedings                                                                                                  |       | 21       |
|          |       | Item 4.                           |       | Submission of Matters to a Vote of Security Holders                                                                |       | 21       |
| PART II  |       | Item 5.                           |       | Market for Registrant’s Common Equity, Related  Stockholder Matters and Issuer Purchases of Equity Securities |       | 22       |
|          |       | Item  6.                          |       | Selected  Financial Data                                                                                           |       | 23       |
|          |       | Item 7.                           |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                        |       | 25       |
|          |       | Item 7A.                          |       | Quantitative and Qualitative Disclosures About Market  Risk                                                        |       | 37       |
|          |       | Item 8.                           |       | Financial Statements and Supplementary Data                                                                        |       | 38       |
|          |       | Item 9.                           |       | Changes in and Disagreements With Accountants on  Accounting and Financial Disclosure                         |       | 66       |
|          |       | Item 9A.                          |       | Controls and Procedures                                                                                            |       | 66       |
|          |       | Item  9B.                         |       | Other  Information                                                                                                 |       | 70       |
| PART III |       | Item 10.                          |       | Directors and Executive Officers of the Registrant                                                                 |       | 71       |
|          |       | Item 11.                          |       | Executive Compensation                                                                                             |       | 71       |
|          |       | Item 12.                          |       | Security Ownership of Certain Beneficial Owners and  Management                                                    |       | 71       |
|          |       | Item 13.                          |       | Certain Relationships and Related Transactions                                                                     |       | 71       |
|          |       | Item 14.                          |       | Principal Accounting Fees and Services                                                                             |       | 71       |
|          |       | Item 15.                          |       | Exhibits, Financial Statement Schedules, and Reports on  Form 8-K                                             |       | 72       |
|          |       |                              |       | Signatures                                                                                                         |       | 73       |
| Schedule II   |       | Valuation and Qualifying Accounts |       | 75                                                                                                                 |
|          |       |                              |       | Exhibit Index                                                                                                 |       | 76       |

 

 

 

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***Disclosure Regarding Forward-Looking Statements***

*Readers are cautioned that this Annual Report on Form 10-Kcontains forward-looking statements within the meaning of Section 27A ofthe Securities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended, (“Exchange Act”) relating to our operationsthat are based on our current expectations, estimates and projections. Wordssuch as “expect,” “believe,” “anticipate,” “plan,” “intend” and similar expressions are used to identify theseforward-looking statements. These statements are not guarantees of futureperformance and involve risks, uncertainties and assumptions that are difficultto predict. Our actual results may differ materially from what is expressed orprojected in these forward-looking statements. The reasons for this include thefactors discussed in Item 1A Risk Factors of this Annual Report on Form 10-K.We specifically disclaim any obligation to update these forward-lookingstatements. These forward-looking statements should not be relied on asrepresenting our estimates or views as of any subsequent date.*

**PART I**

**ITEM 1.**                BUSINESS

**Overview**

Founded in 1983, GTSI Corp. is a Delaware corporationwith more than 20 years of experience focused exclusively on selling IT productsand solutions to U.S. Federal, state and local governments. We use the terms “GTSI,”“we,” “our,” and “us” to refer to GTSI Corp. and its subsidiaries. During thisperiod, our customers have come to rely on GTSI to translate businesschallenges into practical technology solutions for today’s governments. Weharness IT’s leading vendors, products and services inside the core technologyareas most critical to government success. “GTSI” is a registered service markof GTSI Corp. All other trademarks and service marks are proprietary to theirrespective owners.

Wesell to departments and agencies of the U.S. Federal Government, as well asstate and local governments, and prime contractors. Our total sales were $886.3million, $1.1 billion and $954.1 million for the years ended December 31,2005, 2004 and 2003, respectively. We offer a competitive mix of logistical and procurement support to ourcustomers. The approximate percentage of our sales by customer type forthe years ended December 31 was:

| ** **                   | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------|------------|----------|------------|----------|------------|----------|------------|
| U.S. Federal  Government     |       |     | 71         | %        |       |     | 75         | % |   |   | 80 | % |   |
| Prime Contractors            |       |     | 21         |     |       |     | 20         |   |   |   | 17 |   |   |
| State and Local  Governments |       |     | 8          |     |       |     | 5          |   |   |   | 3 |   |   |
| Total                        |       |     | 100        | %        |       |     | 100        | % |   |   | 100 | % |   |

 

Additional information related to net (loss) income,total assets, significant customers and long-lived assets is provided in theconsolidated financial statements and in Note 14 of the consolidated financialstatements appearing in Part II, Item 8 of this Annual Report on Form 10-K.

We faced several challenges during 2005 as a result ofa changing government marketplace, the implementation of our GTSI EnterpriseManagement System (“GEMS”), and employee turnover. In response, at the end of2005 management reaffirmed its goal to pursue a distinctive business model thatcombines the concepts of a value added reseller of complex IT solutions with anefficient reseller of more commodity-like products. We believe this fusion willcreate a strong and solid government technology partner.

The vast majority of the IT solutions we offer to ourcustomers have a strong product component, and many are entirely product-based.The latter are identified and purchased by government procurement officersunder standard government contracts, which range from single agency contractsto those which are available to the entire U.S. Federal Government or stategovernment community (such as U.S. 

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Communities). We areespecially well-positioned to fulfill the requirement of having an appropriatecontract vehicle as we hold a contracts portfolio that includes nearly fourdozen such contracts, and many major Federal agency-specific contracts.

To fulfill productdemand, GTSI maintains a 140,000 square-feet distribution and integrationcenter in Northern Virginia, immediately adjacent to Washington DullesInternational Airport. We use this proximity in concert with close systemsrelationships with our customers and vendors to assure timely delivery for ourcustomers’ mission-critical applications. We leverage our distribution andintegration center and matching logistics expertise to offer a wide variety ofmanaged fulfillment and value added services such as:

·       Hardwareintegration;

·       Customerimage propagation;

·       Automatedsystem diagnostics and data capture;

·       Customerasset tagging; and

·       Complexconfigurations of various IT Solutions, such as Voice over Internet Protocol.

Both our distribution and integration operations arefully ISO certified.

To help our customersacquire, manage and refresh this technology in a strategic andapplication-appropriate manner, GTSI has created a mix of financial servicescapable of managing the entire technology lifecycle. GTSI offers leasearrangements to allow government agencies to acquire access to technology as anevenly distributed operating expense, rather than the much more budget-sensitiveand discontinuous capital expenses. This is especially important to agencieswhose budget planning requirements span many forward-looking years, but whosetechnology needs cannot be accurately planned on the same timeline. It alsoappropriately helps agencies keep their information management resourcesfocused on the flow and security of agency information, rather than ownershipof the technology itself. This model is in high demand from our customers, andwe believe it represents a distinctive GTSI solutions advantage.

**Going Concern**

Our independent registered public accounting firm,Ernst & Young LLP, has concluded that substantial doubt exists aboutour ability to continue as a going concern, and has included that conclusion inits audit report on our consolidated financial statements for the year ended December 31,2005 included in this Annual Report on Form 10-K. GTSI incurred anet loss of $16.0 million for the year ended December 31, 2005 and has notcomplied with certain covenants of our $135 million revolving credit facility with a group of banks (the “CreditFacility”). Our lenders have notified us that our Credit Facility willterminate on the annual renewal date of May 31, 2006. As a result, we willneed a replacement credit facility to meet our capital needs for the remainderof 2006 and beyond.

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In the absence ofreceiving a revolving credit facility, management does not believe that ourexisting capital resources will enable us to fund operations for the next threemonths. Management plans to obtain alternative financing under a revolvingcredit facility with new lenders prior to the expiration of our CreditFacility. We did not include any adjustments to the consolidated financialstatements included in this Form 10-K to reflect the possible futureeffects that may result from the uncertainty of our ability to continue as agoing concern because we are confident that we will continue to be afinancially sound and viable business, providing quality service to ourgovernment customers, attractive employment opportunities for our employees andlong-term value to our stockholders. We expect to obtain a replacement creditfacility in the near future and we believe we are taking the necessary actionsto improve our cash flows. We are currently undertaking the following effortsto address this uncertainty:

·       OnApril 10, 2006 we signed a commitment letter to negotiate a new revolvingcredit facility with two major money center banks by May 31, 2006, theexpiration date of the current Credit Facility;

·       Weare working to strengthen the core operating processes of the supply chain andimprove productivity;

·       Weinitiated significant reductions in workforce in October 2005 and February 2006to reduce our costs, eliminating over 100 full time positions;

·       Wehave concerted efforts underway to improve working capital by collecting agedreceivables, increasing the amount of partial billings, and invoicing customersas soon as allowed; and

·       In the fourth quarter of2005, we developed a strategic plan to identify and exit failing ornon-strategic activities, improve execution of our current business, and emergeas a high-value solutions provider, as described in our Business Strategysection below.

**Business Strategy**

GTSI is committed to and focused on the governmentcustomer. We believe there are significant opportunities to realize improvedprofitability through our existing business, and to increase our relatively lowmarket share within the growing government IT market.

Our vision is to become aleading supplier of IT solutions to our government customers, and to continuetaking advantage of the robust government IT market. During 2005, managementcreated a plan with three elements consistent with our goals: to identify andexit failing or non-strategic activities, improve execution of the currentbusiness, and emerge as a high value solutions-provider. These elements aredetailed below.

*Identify and ExitFailing or Non-Strategic Activities*

We expect to be moresuccessful by better focusing our many efforts, doing more profitable andstrategic activities, and doing fewer activities which are either notprofitable or non-strategic. We have reviewed our various activities andeliminated or scaled back poor performing sales teams and are in the process offocusing our marketing and sales efforts on the products, services and vendorswhich are most profitable. We have reviewed our organization to eliminateduplicative activities and create lines of accountability. The result of theseefforts resulted in two reductions in work force: one in October 2005 anda second in February 2006. We continue to measure the performance ofvarious customer teams and lines of business, and adjust our resources toensure that they are being deployed to maximum advantage.

*Improve Execution*

Our goal continues to beto create margin improvement through process improvement and cost reductions.The implementation of the GEMS system in 2005 put significant strain on ourorganization and 

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exposedseveral process inefficiencies throughout GTSI. We believe we can reduceoperating costs, improve customer service and improve cash flow through aconcerted effort to improve our supply chain and delivery processes. Werecently aligned our organization to put all supply-chain and IT activities inone organization to drive the various initiatives to realize the benefits ofimproved execution. We have begun to map various processes and will be takingadditional action intended to improve our current business activities.

*Emerge as aHigh-Value Solutions Provider*

GTSI continues to evolveas a provider of value-added solutions consisting of both products and servicesto our government and system integrator customers. We have been successful inproviding technical assistance to support complex, multi-vendor solutions; inproviding GTSI and third-party services; and in teaming with other serviceproviders on large, more complex bids. While larger sales transactionsrepresent a small percentage of our total transactions, they represent themajority of our margin and profits. Going forward, we will continue to focus onthese larger, more profitable transactions, and drive processes and changes tomake the delivery of the smaller transactions more profitable. In addition, wewill continue to take other action to create and maintain a profitable company.Specifically, we plan to:

*Focus on theGrowing Government IT Market*

Because of our historical focus on government, GTSIhas developed the expertise and established the vendor and customerrelationships necessary to be a leader in this market. As a result, ourmarketing and sales force are effective at reaching and servicing thegovernment market, which consists of procurement and contracting officers,information resource managers, Chief Information Officers, government ITexecutives, systems integrators, value-added resellers, prime contractors and awide array of end-users.

*Execute NewGovernment Contracts and Utilize Flexible Contract Vehicles*

GTSI holds a wide range of government contracts,including multi-million dollar, multi-year contracts with the Department ofDefense (“DoD”) and various civilian agencies, as well as several multipleaward schedules and blanket purchasing agreements with a variety of DoD andcivilian agencies. We also serve as a subcontractor, providing products andservices to other companies holding government contracts. GTSI intends tocontinue identifying and pursuing contract vehicles that best leverage ourbroad selection of solutions, services, integration and distribution capabilitiesand vendor relationships.

*Provide aHigh-Quality Centralized Source for Procuring IT Products and Services*

In addition to offering a full line of computerhardware, software and peripheral products, GTSI offers its customers pre- andpost-sale technical support and assistance in the selection, configuration,installation and maintenance of the products and systems that we sell.Furthermore, by offering a range of IT solutions and products through a varietyof procurement mechanisms, we offer our customers the convenience, flexibilityand cost savings of purchasing from a centralized source. In our interactionswith our customers, our employees focus on providing high quality customerservices associated with the order, delivery, installation and repair of theproducts we sell. In addition to our product offerings, we now offer servicesolutions to meet our customer needs in networking and telecommunications,storage and continuity of operations solutions, enterprise software deployment,and managed logistics support.

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*Establish andMaintain Strong Vendor Relationships*

To provide a centralized source of products andsolutions for our customers, GTSI maintains strong relationships with leadinghardware, software and services vendors. GTSI offers our vendors a wide rangeof marketing and sales services, which provide them with access to the millionsof end-users constituting the government market. In addition, we insulate ourvendors from the procurement regulatory complexities, costs and complicatedbilling requirements associated with the government market.

**Customers**

GTSI’ssales are predominantly generated from multiple agencies and departments of theU.S. Federal Government, either directly or ultimately through primecontractors. Our sales from the U.S. Federal Government (both directly andindirectly) accounted for approximately 92%, 95%, and 97% of our sales during2005, 2004 and 2003, respectively. U.S. Federal Government sales were earnedfrom numerous agencies and departments as approximated below:

| ** **                         | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Department of  Defense             |       |     | 35         | %        |       |     | 37         | % |   |   | 41 | % |   |
| Civilian Agencies  and Departments |       |     | 42         |     |       |     | 42         |   |   |   | 41 |   |   |
| Prime Contractors                  |       |     | 23         |     |       |     | 21         |   |   |   | 18 |   |   |
| Total                              |       |     | 100        | %        |       |     | 100        | % |   |   | 100 | % |   |

 

**Contracts**

GTSI achieves its salesthrough Federal, state and local government contracts and open marketprocurements. Our contracts with the U.S. Federal Government include a GeneralServices Administration (“GSA”) Schedule contract, IndefiniteDelivery/Indefinite Quantity (“IDIQ”) contracts and Blanket Purchase Agreements(“BPAs”). We pursue formal government bids for IDIQ contracts and BPAs.Substantially all of these bids are awarded on a “best value” to the governmentbasis (which, depending on the bid, can be a combination of price, technicalexpertise, past performance on other government contracts and other factors).We seek to use our vendor contacts, purchasing power, distribution strength andprocurement expertise to compete successfully on these bids. These majorprocurements may equal millions of dollars in total sales, span multiple yearsand provide a purchasing vehicle for many government agencies. In some cases,various government agencies levy an administrative fee on purchases made bydepartments outside of the agency that awarded the contract. These fees arecollected by GTSI and remitted to the respective agency on a contract specifiedpayment schedule. Items offered under our contracts include platform solutions,peripherals, maintenance, training and services. All of our contracts allow forthe addition of products under certain circumstances. Additional detailsregarding our platform solutions and peripherals are provided in the Products,Solutions, and Services subheading in this Business section.

*General ServicesAdministration*

GTSI holds a GSA designated Schedule 70 contract forthe sale of IT products and services. Schedule 70 contracts are multi-awardschedule contracts managed by the GSA IT Acquisition Center. In March 2002,the U.S. Federal Government formally exercised its first of three five-yearoptions to extend the GTSI contract through 2007. GSA contracts provide allgovernment agencies, certain international organizations, authorized primecontractors, and state and local governments with an efficient andcost-effective means for buying commercial products. GSA purchasers may placeunlimited orders for products under GSA contracts.

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Our GSA contract containsprice reduction clauses requiring that we pass on to government customerscertain reduced prices we may receive from our vendors, but prohibits us frompassing on price increases for a period of one year. To mitigate thepotentially adverse impact of any such price increase, we require substantiallyall of our vendors who supply our GSA contract to provide us with supply andprice protection.

*IndefiniteDelivery/Indefinite Quantity*

IDIQ contracts offer greater flexibility than GSAcontracts because they allow products to be added quickly and allow contractorsmore pricing flexibility. IDIQ contracts are pre-competed; therefore, ordersplaced under these contracts are not subject to formal protest unless the orderis beyond the scope of the contract. There are three types of IDIQ contracts:government-wide acquisition contracts (“GWAC”), multi-agency contracts (“MAC”),and single agency contracts. A GWAC is a task-order or delivery-order contractfor information technology established by a single Federal agency forgovernment-wide use upon approval by the Office of Management and Budget, whileMACs accept orders from other agencies under the authority of the Economy Act.

Detailsregarding our IDIQ contracts are as follows:

| **Contract Name**                                       | ** ** | ** **    | ** ** | **IDIQ Type**           | ** ** | **Contracting Agency** | ** ** | **Expiration Date** |
|---------------------------------------------------------|------------|---------------|------------|-------------------------|------------|------------------------|------------|---------------------|
| Scientific Engineering  Workstation Procurement III (a) |       | GWAC          |       | NASA                    |       | July 30, 2006     |
| Electronic Commodity Store  III                         |       | GWAC          |       | NIH (b)                 |       | Nov. 26, 2012     |
| Maxi-Minis and Databases                                |       | MAC           |       | Army                    |       | May 25, 2006      |
| Information Technology  Enterprise Solutions            |       | MAC           |       | Army                    |       | Nov. 1, 2006      |
| Procurement of Computer Hardware and Software-2         |       | single agency |       | Veterans Administration |       | April 3, 2007(c)  |

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(a)           Comprises threecontracts which each relate to a specific category of IT products

(b)          National Institute ofHealth

(c)           Contract containsextension options

The products are soldunder the contract at a fixed price; however, the government typicallynegotiates a lower price for large quantity or high value orders.

*Blanket PurchaseAgreements*

Individual GSA ordering agencies may enter intoGSA-authorized BPAs with GSA contract holders. BPAs are similar to second-tiercontracts under a contractor’s GSA contract. BPAs enable agencies to obtainbetter pricing based on volume ordering and they decrease an agency’sadministrative costs by streamlining the ordering process.

GTSI maintains severalFederal Supply Schedule BPAs that are authorized under our GSA Schedule 70contract. GSA authorized BPAs incorporate many terms, conditions and productsoffered on GSA Schedule contracts, often at prices lower than those availableon the GSA schedules. We normally enter into separate agreements with vendorsto offer reduced BPA prices to the government. Our BPAs are agency specific andallow us to focus specific vendor relationships on specific customers.

*State and Local*

In 2003, GTSI was awarded U.S. Communities, amulti-state contract available to cities, counties, special districts (airport,water, etc.), state agencies, schools and large non-profits such as hospitalsand clinics. In addition, GSA now allows state and local government agencies toutilize GSA Schedules. Multi-

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state contracts enableindividual states to utilize the buying power of multiple states, which resultsin lower costs based on volume purchasing. The initial term of the U.S.Communities contract expires on May 1, 2006 and the contract has threeone-year extension options.

The products are sold under the contract at a fixedprice; however, governments typically negotiate a lower price for largequantity or high value orders. In addition, these contracts include anadministrative fee calculated on the product price. We collect this fee andremit it on a quarterly basis to the contract’s administering agency.

Many purchases in thestate and local government market are still made through individual competitiveprocurements, although many state and local governments issue invitations tobid for statewide computer term contracts. State and local procurementstypically require formal responses from a prospective bidder. Each statemaintains a separate code of procurement regulations that must be understood.Compliance is required to successfully market and sell to individual states.GTSI currently maintains several state and local IT contracts, regularlysubmits oral and written bids to state and local governments and is on a numberof state and local government bid lists.

*Open Market*

We also sell many ITproducts through open market procurements. These procurements are separate andapart from GSA Schedules, IDIQs and BPAs. Open market procurements includesimplified acquisition procedures, requests for quotes, invitations for bidsand requests for proposals. GTSI is on most government bid lists relevant toits product offerings and responds with proposals to hundreds of such bidsolicitations each year. We also sell to prime contractors to the government,including systems integrators, through open market procurements.

**Products, Solutionsand Services**

GTSI continuously monitorsand evaluates existing and emerging technologies to ensure that they offer ourcustomers the most appropriate technology for their demanding applications.GTSI also offers simplified buying to our customers through our e-commercewebsite, GTSI.com, as well as a growing number of agency, program andvendor-specific sub-webs and portals.

*Hardware*

GTSI has strong strategicrelationships with global hardware-market leaders. We also have resourcesdedicated to incubating new vendors as technology develops and emerges. In ourtraditional reseller capacity, we provide government with products forworkgroup computing, such as workstations and desktops; mobility computing andcommunications, such as wireless-equipped notebooks and PDAs; core computing,such as servers, high-end computing, and storage systems; networking productsfor LANs, WANs, MANs and personal area networks; and a wide range ofperipherals such as disk drives, printers, monitors, scanners, modems andrelated products. Our core service mix helps customers make the greatestproductive use of this technology by assisting them in selecting, configuring,installing and maintaining the components that populate today’s multi-functionnetworks.

*Software*

We provide softwareproducts from most leading desktop and enterprise software providers, includingAdobe, BEA Systems, Citrix Systems, Computer Associates, IBM, McAfee, MercuryInteractive, Microsoft Corporation, Red Hat, Symantec/Veritas, and VMWare. GTSI’sstable of software provider relationships is both broad and strong.

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*Solutions*

During 2005, webegan a realignment of marketing emphasis around a focused number ofapplication areas in which our government customers have consistentlydemonstrated the greatest immediate strategic interest, and which provide uswith the greatest opportunity for sustained return on investment. This emphasisis increasingly revolving around solutions designed to address mission-criticalchallenges common to many government agencies. Our primary solution attentionis being directed toward:

·       ITconsolidation, especially for servers and storage systems;

·       Disasterrecovery and backup;

·       Mandatesfor agency migration to next-generation networks, including support for IPv6and VoIP;

·       E-mailmanagement, especially for archiving, security, infrastructure support, andmigration;

·       Mobile-enableddata management for field knowledge workers and enforcement personnel; and

·       Visualcommunication support for remote workers and distributed offices, includingcollaboration, presentation, and broadcast systems.

Each GTSI solution starts with standard componentsbuilt around a custom deployment model that is determined through ourassessment of the customer’s complete application environment. This action plandraws on approaches and technology created across many of our projects to helpdrive any given project to rapid delivery. It is this combination of coreservices and approaches that we believe best helps our customers meet theircritical budget and deadline requirements.

A typical GTSIsolution may draw from any of these core services:

·       Needsanalysis and environment assessment;

·       Professionalservices, including project planning and management, engineering, implementationand training;

·       Financialservices to evenly distribute cash flow requirements for technology refreshesand buying cycles;

·       Systemsintegration and configuration, including code load and light assembly; and

·       Managedfulfillment across multiple products and locations.

GTSI provides theseservices with technology embedded in off-the-shelf products drawn from a corepool of industry-technology innovators. This pool currently includes PanasonicComputer Company, Cisco Systems, Sun Microsystems, Hewlett-Packard DevelopmentCompany (HP), International Business Machines (IBM), Silicon Graphics, Inc.(SGI), Network Appliance, Apple Computer, American Power Conversion Corporation(APC), and Microsoft Corporation, among many others.

*Services and Warranty*

We professionally manage the creation and delivery ofall services to our customers either using our internal resources orsubcontracting to a third-party service provider. GTSI typically offerswarranties on products for the same term as the manufacturer’s warranty. Wealso sell extended warranties ranging from three to five years beyond themanufacturer’s warranty on certain products.

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Thefollowing table indicates, for the years ended December 31 (dollars inmillions), the approximate sales by product category along with relatedpercentages of total sales.

| **Products**       | ** ** | ** ** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|
| Hardware           |       | $          | 677.7      |     | 76.5       | %        | $          | 834.1    |       | 77.5 | % | $ | 692.5 |   | 72.6 | % |
| Software           |       | 141.6      |       | 16.0     |       | 155.7    |       | 14.5     |       | 154.5 |   | 16.2 |   |
| Resold third-party |       |       |       |     |       |     |       |     |       |   |   |   |   |
| service products   |       | 48.9       |       | 5.5      |       | 66.6     |       | 6.2      |       | 91.2 |   | 9.5 |   |
| Services           |       | 18.1       |       | 2.0      |       | 19.7     |       | 1.8      |       | 15.9 |   | 1.7 |   |
| Total              |       | $          | 886.3      |     | 100.0      | %        | $          | 1,076.1  |       | 100.0 | % | $ | 954.1 |   | 100.0 | % |

 

**VendorRelationships**

To offer ourcustomers a centralized source for their IT needs, we establish and maintainrelationships with key vendors. GTSI offers vendors a number of advantages,including:

·       Proactivesales of products and solutions;

·       Accessto the government market through a significant number of diverse contractvehicles;

·       Helpingto lower costs to comply with procurement regulations involved in sellingdirectly to the government market; and

·       Facilitatingthe reduction of costs related to reduction or elimination of selling,marketing and various administrative programs.

The terms of agreements with our vendors vary widely,but typically permit us to purchase products for resale (with subsequent systemintegration and professional services as needed) to the government market.Virtually none of our agreements require us to purchase any specified quantityof product. GTSI typically requires vendors, acting as suppliers to us underour term government contracts, to provide us with supply and price protectionfor the duration of such contracts. Other than supply agreements under termgovernment contracts, our vendor agreements are typically terminable by GTSI orthe vendor on short notice, at will or immediately upon default by eitherparty, and may contain limitations on vendor liability. These vendor agreementsalso generally permit GTSI to return previous product purchases at no chargewithin certain time limits for a restocking fee or in exchange for otherproducts of such vendor.

Our vendors provide uswith various forms of marketing and sales assistance, including salesincentives and market development funds. Vendors provide sell-through and othersales incentives in connection with certain product promotions. Additionally,key vendors participate with us in cooperative advertising and sales events andtypically provide funding that can offset all or part of the costs of suchefforts.

**InventoryManagement**

We purchase products for resale both directly frommanufacturers and indirectly through distributors and other sources. During2005, we purchased approximately 75% of the products we sold directly frommanufacturers and the remaining amount from distributors and other sources. Ourdistribution process is highly automated with a real-time shipment tracking andstatus system. All product picking is performed using bar-coded labels, UPC barcodes and radio frequency scanning. We implemented an RFID Solution in January 2005,which enables us to apply RFID tags to case and pallet-load shipments that meetpublished DoD requirements. We have dedicated teams to perform cycle counts,process customer returns and receive products.

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We generally ship productsby UPS, FedEx, Conway and other commercial delivery services and, whereapplicable, invoice customers for shipping charges.

**Marketing and Sales**

Our marketing department develops and manages ourbranding and positioning activities, which span all print, electronic and livemedia within our target market. These activities inform our governmentcustomers and prospects of our capabilities and the GTSI value proposition,helping us acquire new customers and retain existing business relationships.Many of these activities are funded by our vendors in exchange for the marketentry that GTSI relationships and expertise offer in selling to the government.

Our marketing activities include sponsorship of majortrade shows, private customer-education events, display advertising in printand broadcast media, corporate and solutions-focused collateral, the GTSI.come-commerce Web site, targeted e-mail marketing, outbound telemarketing, andsales-related incentive programs.

We recognize that the size and diversity of thegovernment market make it imperative for us to identify and understand theneeds of our customers. Through years of intensive effort, GTSI has compiledand maintained a proprietary database that contains an extensive list of agencyprocurement and contracting officers, information resource managers, seniorpolicy makers, technology influencers, end-users, systems integrators, valueadded resellers and prime contractors. We use this database to target ourmarketing efforts and perform data mining for various market research purposes.

Our sales organization isfocused on understanding the current and emerging needs of our customers and toprovide products, services and bundled solutions to meet those needs. Our salesorganization continues to provide deep coverage for existing customers whileexpanding sales coverage to focus on new accounts and new product and serviceofferings to current customers.

**Competition**

The government IT market is highly competitive, andsubject to rapid change. GTSI competes with a number of competitors, includingtraditional hardware and software resellers, systems integrators, commercialcomputer retail chains and distributors.

We believe that theprincipal competitive factors in the government IT market are:

·       Price(for highly commoditized technology);

·       Expertisein government procurement processes (where standardized contracts exist);

·       Existingcustomer and vendor relationships (for which there is traditionally a highbarrier to entry);

·       Technicalexpertise;

·       Logisticalcapability; and

·       Customerservice and support.

In recent years, competition within the traditionalreseller portion of our business has consolidated and intensified. Pricingpressure in particular has been and remains intense. We believe that price competition will continue to increase in2006, as consolidation continues and competitors rationalize their completesupply chain. This competition may require us in some cases to reduce prices,increase advertising expenditures or undertake other actions to retain ourstrategic position. Decreasing prices require us to sell a greater number ofproducts to achieve the same level of sales and gross margin. If this trendcontinues and we are unable to attract new customers and sell increasedquantities of products or modify our strategy, our future sales and grossmargins may be adversely affected.

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Scaleand scope are important dimensions in the government technology supply chain. Anumber of competitors to our system integration business are much largerthan GTSI, and have far greater financial, marketing and technologicalresources. This difference in scale could in some cases produce a materialimpact on the promotional and sales support requirements of our business. Webelieve we have a competitive advantage over certain of our competitors becauseof our strong brand among government customers, our extensive contractportfolio and our wide variety of vendors.

**Backlog**

We identify an order asbacklog as soon as we receive and accept a written customer purchase order.Backlog fluctuates significantly from quarter to quarter because of theseasonality of the U.S. Federal Government ordering patterns and changes ininventory availability of various products. Our total backlog includes orders thathave not shipped (“unshipped backlog”) as well as orders that have shipped butcannot be recognized as revenue at the end of the reporting period, since titlepasses to our customers when the orders reach the destination. Total backlog atDecember 31, 2005 was $134.3 million compared to $86.8 million at December 31,2004. Unshipped backlog at December 31, 2005 was approximately $126.0million, compared to $81.5 million at December 31, 2004.

**Employees**

At March 17, 2006 wehad 732 employees, including 506 in sales, marketing and professional services;40 in operations; and 186 in finance, IT, contracts and legal, and othersupport functions. None of our employees are represented by a labor union andwe have experienced no labor-related work stoppages.

**AvailableInformation**

GTSI is traded on the NASDAQ National Market under thesymbol GTSI (See Item 5 of this Annual Report on Form 10-K). Our annualreports on Form 10-K, quarterly reports on Form 10-Q,current reports on Form 8-K, proxy statements for our annualstockholders’ meeting, and amendments to those reports filed or furnishedpursuant to Section 13(a) or 15(d) of the Exchange Act are madeavailable free of charge on our web site at www.gtsi.com as soon as reasonablypracticable after we electronically file such material with, or furnish it to,the Securities and Exchange Commission. All of GTSI’s current required ExchangeAct filings with the SEC, as well as press releases and other investorrelations’ information, may be obtained free of charge by request to: InvestorRelations, GTSI Corp., 3901 Stonecroft Boulevard, Chantilly, VA 20151-1010.Telephone (703) 502-2540.

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**ITEM 1A.**        RISKFACTORS

There aremany factors that affect our business and results of operations, some of whichare beyond our control.The following is a description of some important factors that may cause actualresults to differ materially from those in forward-looking statements and fromhistorical trends.

***We are uncertain of our ability to meet the covenantsunder our Credit Facility in future periods and we are uncertain of our abilityto obtain alternative financing for our future capital needs. If we fail to bein compliance with any material provision or covenant of our Credit Facility orare unable to obtain alternative financing, we may not be able to continue tooperate our business.***

In February 2006, we received a notice of defaultfrom our lenders of certain covenants under our Credit Facility. As of January 31,2006 we defaulted on the following financial covenants under the CreditFacility: (i) maximum funded indebtedness to EBITDA, (ii) minimumEBIT to net sales, and (iii) minimum tangible net worth. Our lendersrequested the execution of an agreement to temporarily forbear them fromenforcing their rights and remedies as a result of the events of default. On April 3,2006, we defaulted on a covenant under the Credit Agreement when we received astaff determination letter from The NASDAQ National Market stating that becausewe had not filed our Annual Report on Form 10-K for 2005 with theSEC, as required by Market Place Rule 4310(c)(14), GTSI’s common stock issubject to delisting from the NASDAQ National Market. We have requested ahearing with NASDAQ which should stay the delisting pending the determinationof NASDAQ’s hearing panel. While there is no assurance, we expect to avoiddelisting of our common stock from The NASDAQ National Market by the filing ofthis Form 10-K. A forbearance agreement (“Credit Agreement”),effective February 28, 2006, was executed between GTSI and our lenders on March 10,2006.

The covenants ofour Credit Agreement impose certain operating restrictions and financial andreporting covenants on us. These restrictions and conditions may affect ourability to operate our business and may limit our ability to take advantage ofpotential business opportunities as they arise. These covenants require us,among other things, to:

·       Providea variety of weekly, semi-monthly, and monthly financial reports addressing keyaspects of GTSI’s operation including weekly cash flow projections, analyses ofaged collections, inventory reports and daily borrowing base certificates;

·       Maintaina minimum tangible net worth of $50 million as of the last day of each month;

·       Maintainspecified total liabilities to tangible net worth ratios;

·       Notexceed the maximum aggregate pre-tax losses on a monthly basis as specified inthe Credit Agreement; and

·       Engagea restructuring advisor to, among other things, evaluate our financial plansand alternatives.

Our ability to comply with these covenants may beaffected by events beyond our control, and unanticipated events could requireus to seek waivers or amendments of covenants or alternative sources offinancing or to reduce expenditures. We cannot assure you that such waivers,amendments or alternative financing could be obtained, or if obtained, would beon terms acceptable to us.

A breach of any of the covenants or restrictionscontained in our Credit Agreement could result in an event of default underthat agreement. We cannot assure you that we will be able to comply with thecovenants to which we are subject in the future and, if we fail to do so, thatwe will be able to obtain waivers from our lenders or amend the covenants. Sucha default could allow the lenders to discontinue lending or declare allborrowings outstanding to be due and payable. If any of these events occur, wecannot assure you that we will have sufficient funds available to pay in fullthe total amount of obligations 

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that become due as aresult of any such acceleration, or that we will be able to find additional oralternative financing to refinance any such accelerated obligations.

We are currently innegotiations with several leading financial institutions seeking to securelong-term financing. On April 10, 2006 we signed a commitment letter tonegotiate a new revolving credit facility with two major money center banks by May 31,2006, the expiration date of the current Credit Facility. We cannot assure youthat any such funds will be available to us on favorable terms or at all. Ifsuch funds are unavailable to us, we may not have enough cash to meet ouroperating needs.

***Infrastructure failures could have a material adverseaffect on our business.***

We are highly dependent on our infrastructure toprocess orders, track inventory, ship products in a timely manner, prepareinvoices to our customers, recognize revenue and otherwise carry on ourbusiness in the ordinary course. The implementation of GEMS resulted inproblems which disrupted our business and adversely affected our sales andmargins.

In April of 2005, GTSI went live with a newsupply chain management system based on software provided by PeoplesoftCorporation, the GTSI Enterprise Management System (“GEMS”). Management hadplanned extensively for this implementation, and had invested a considerablesum of money training associates from a variety of functional disciplinesthroughout the supply chain.

For the first 90 days after go-live, we encounteredmany significant issues in every area of the supply chain. These issuesresulted in significant productivity issues that we spent the rest of the yearrecovering from. Dozens of bug fixes and patches to the software were required.While the software was operating significantly better after the first 90 days,many core processes were not fully stabilized and were not as efficient as withthe previous system. For the remainder of the year, a significant number ofenhancements and additional reporting capabilities were added which enabledmanagement to make better decisions based on the information available. As of December 31,2005, core processes were stabilized with many active programs underway tocontinue to improve core processes during 2006.

The ongoing use ofGEMS involves numerous risks including:

·       difficultiesin integrating the system with our current operations;

·       thebuild-up of excess and obsolete inventory from duplicate orders and higher thanusual customer returns;

·       diversionof management’s attention away from normal daily operations of our business;

·       initialdependence on an unfamiliar system while training personnel in its use;

·       additionalexpenses and cash outlays for the maintenance and upkeep of the software;

·       difficultiesin obtaining reports to accurately present our external financial results;

·       increaseddemand on our support operations; and

·       potentialdelay in the processing of customer orders for shipment of products.

As a result of the above,our business, operating results and financial condition were adversely affectedduring 2005 and could continue to be impacted in future periods.

***We are exposed to inventory risks.***

We are exposed to inventory risks as a result ofbalancing the need to maintain appropriate inventory levels to ensurecompetitive lead times against the risk of inventory obsolescence because ofrapidly changing technology and customer requirements. We seek to minimize ourinventory exposure through a 

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variety of inventorymanagement procedures and policies, vendor price protection and product returnprograms. Additionally, more than one-half of our product sales are shippeddirectly from our vendors to our customers.

However, as a result ofdifficulties in our implementation of GEMS and the related distraction ofemployees from managing sales returns and inventory levels, excess inventorybegan to accumulate in the second quarter of 2005. Management became aware ofthe magnitude of this issue during the fourth quarter of 2005, performedanalyses and refocused our attention on effective inventory management. As aresult, management determined that a reduction of $5.6 million was necessary tofairly state inventory at the lower of cost or market as a result of obsoleteand excess inventory. In the future, if we determine that we have additionalinventory exposure, we may have to reduce our prices or write-down additionalinventory, which in turn could result in lower gross margins.

***We face certain risks as a result of changes in ourmanagement team, including our Chief Executive Officer, who resigned February 15,2006.***

Our success depends inlarge part on the contributions of our management team. Over the past fewyears, we have experienced significant changes in our management team. Forexample, the following executives terminated their relationship with GTSI: ourSenior Vice President of Sales in July 2005; our Senior Vice President,Program and Information Services in February 2005; our former Presidentand Chief Operating Officer in May 2004; and our former Controller in May 2004.Although we do not believe that the departure of any one of these individualshad a significant negative impact on our business, we face operationalchallenges as a result of this turnover because some members of our managementteam are still learning about our company operations. If we do not succeed insolving the operational challenges we face in connection with the changes toour management team, we could suffer a significantly adverse impact on thedevelopment of our business.

***We have material weaknesses in our internal controlover financial reporting which could have a material adverse effect on ourbusiness and a negative impact on our stock price.***

In our preparation of the consolidated financialstatements for the year ended December 31, 2005, management identifiedthree material weaknesses in our internal control over financial reporting thatexisted as of December 31, 2005, which resulted in errors in our 2005financial statements and required a restatement of our consolidated financialstatements for the first three quarters of 2005. A material weakness is acontrol deficiency, or combination of control deficiencies, which results inmore than a remote likelihood that a material misstatement of the annual orinterim financial statements will not be prevented or detected. See Managements’Report on Internal Control over Financial Reporting in this Annual Report on Form 10-Kfor a description of these material weaknesses.

Although we are currently in the process ofimplementing remediation measures to correct these material weaknesses, we canprovide no assurance that we will be successful in these efforts or that theremediation measures will result in our having adequate internal control overfinancial reporting in the future. In addition, we cannot assure you that wewill not in the future identify further deficiencies or weaknesses in ourinternal control over financial reporting. If we are unable to adequatelyremediate our material weaknesses and maintain an effective system of internalcontrol, our ability to timely and accurately report financial results maycontinue to be adversely affected, which could have a material adverse effecton our ability to operate our business. Any failure to file periodic reports ona timely basis could have many consequences, including: potential delistingfrom NASDAQ, which would significantly impair the ability of our investors tobuy and sell shares; lack of the timely disclosure to the market of ourfinancial results; actions by the SEC against us for failure to comply withapplicable Federal securities laws; our inability to use certain short formregistration statements; and an event of default under the Credit Agreementwith our lenders which would cancel our Credit Facility and cause alloutstanding loan 

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obligations to becomeimmediately due and payable. In addition, we may incur substantial costs inconnection with these remediation measures and the implementation of suchmeasures may distract management from its ordinary business functions.

We will need to hire andsuccessfully integrate additional qualified personnel in our accounting,finance, and operations functions to handle the increased complexity of ourbusiness related to the increase in professional services sales andincreasingly sophisticated leasing transactions. If we encounter difficultiesin attracting or retaining qualified accounting staff, we may not be able toremedy the identified material weakness in our financial close and reportingprocess. The current employment market for qualified individuals withaccounting backgrounds is very competitive, and we may encounter difficulty inidentifying, attracting or retaining such individuals. If we are unable tosuccessfully fill our open positions and increase the technical accountingexpertise of our accounting function, we may not be able to remedy theidentified material weaknesses.

***NASDAQ has informed us that our common stock may bedelisted, and any such delisting could materially impair the ability ofinvestors to trade in our common stock and could have a material adverse effecton stock price.***

On April 3, 2006, we received a staffdetermination letter from The NASDAQ National Market stating that because GTSIhas not filed its Annual Report on Form 10-K for 2005 with the SEC,as required by Market Place Rule 4310(c)(14), GTSI’s common stock issubject to delisting from the NASDAQ National Market. GTSI has requested ahearing with NASDAQ which should stay the delisting pending the determinationof NASDAQ’s hearing panel. While there is no assurance, the Company expects toavoid delisting of its common stock from The NASDAQ National Market by thefiling this Form 10-K for 2005 with the SEC before delisting wouldotherwise take effect.

In addition, ourremediation of certain material weaknesses in our internal controls overfinancial reporting will require extensive time consuming manual processing,which may, in the future, delay completion of our quarterly unauditedconsolidated financial statements. This may prevent us from timely filing ourreports under the Exchange Act, including our Report on Form 10-Qfor the quarter ending March 31, 2006, which would also be a violation ofNASDAQ Marketplace Rule 4310(c)(14), and would subject us to potentialdelisting in the future. If our common stock were to be delisted as a result ofour failure to timely file a future quarterly report on Form 10-Q,the ability of our investors to buy and sell shares could be materiallyimpaired which could negatively impact our stock price. The receipt of thestaff determination letter from NASDAQ triggered a default under our CreditAgreement.

***If we fail to align costs with our sales levels, netlosses will continue.***

Our profitability is a function of our ability togenerate sales, improve our efficiency, and control costs. We plan ouroperating expense levels based primarily on forecasted sales levels. Theseexpenses and the impact of long-term commitments are relatively fixed in theshort-term. A short fall in sales could lead to operating results being belowexpectations because we may not be able to quickly reduce our fixed expenses inresponse to short term business changes. In response to sales short fallsduring the year ended December 31, 2005, we announced reduction inworkforce actions in October 2005 and February 2006 resulting in theelimination of over 100 employee positions. Significant risks associated withreductions in workforce include decreases in employee morale and the failure tomeet operational targets due to the loss of employees.

During the year ended December 31, 2005 weincurred significant costs due to excess and obsolete inventory, increasingsales returns, significant employee turnover, and the impairment of ourdeferred tax asset. In addition, costs increased in our accounting department,and are expected to continue in 2006, related to the restatement of priorquarterly results, increased audit fees due to material weaknesses in internalcontrol over financial reporting and the resulting prior period restatements,expansion of the 

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quantity and level oftechnical expertise of accounting personnel, and the on-going remediation ofsignificant deficiencies and material weaknesses in internal control.

If we are unable tocontrol our costs or generate sales to cover the costs required to run ourbusiness and correct our material weaknesses in internal control over financialreporting, our net losses will continue and our business could be adverselyaffected.

***Our auditor’s report states that the operating lossesand our potential inability to obtain a new revolving credit facility raisesubstantial doubt about GTSI’s ability to continue as a going concern.***

Our independent registered public accounting firm,Ernst & Young LLP, has concluded that substantial doubt exists aboutour ability to continue as a going concern and has included that conclusion inits audit report  on our consolidatedfinancial statements for the year ended December 31, 2005 included in thisAnnual Report on Form 10-K. Ernst & Young LLP’s conclusionis based on our net loss of $16.0 million and use of $42.0 million ofcash in operating activities for the year ended December 31, 2005 and thecurrent status of our Credit Facility. Our lenders have notified us that ourCredit Facility will terminate on the annual renewal date of May 31, 2006.As a result, we will need a replacement credit facility to meet our workingcapital needs for the remainder of 2006 and beyond. On April 10, 2006 wesigned a commitment letter to negotiate a new revolving credit facility withtwo major money center banks by May 31, 2006, the expiration date of thecurrent Credit Facility. No assurance can be given that we will be successfulin obtaining any such financing on acceptable terms, if at all.

The “going concern”opinion may cause concern to one or more of our constituencies of employees,stockholders, customers, vendors, or trade creditors. If any customer’s, vendor’sor trade creditor’s concern changes their business relations with us bystopping work, ceasing sales, requiring sales on cash terms or other changes,these changes may materially adversely affect our cash flows and results ofoperations.

***We rely on a small number of large transactions forsignificant portions of our sales and gross margins, and our operating resultsand cash flows may decline significantly if we fail to secure additional largetransactions.***

We rely on U.S. Federal Government agencies anddepartments to provide a substantial portion of our sales either directly orthrough prime contractors with which we work. We have derived, and believe thatwe will continue to derive, a significant portion of our sales from a limitednumber of projects and transactions with the U.S. Federal Government. For theyear ended December 31, 2005, approximately 3% of our largest customerpurchase orders represented approximately 80% of our gross margins. Thecompletion or cancellation of a large project or a significant reduction inscope would significantly reduce our gross margins. In addition, if we fail tosecure an equal number of large transactions in the future, our results will benegatively impacted.

We have four majorcontracts that are up for re-compete in 2006. As a result of our recent deliveryissues due to the implementation of the final phase of GEMS, we are not certainthat we will obtain the re-competed awards. During 2005, these contractsrepresented approximately 40% of our sales and 35% of our gross margins. Anydispute, failure to exercise an extension, or contract not renewed as a resultof a re-compete could have a material adverse impact on our future operatingresults and gross margins.

***Our ability to shift our business model from areseller of products to a high-end solutions provider has certain risks whichmay impact future results.***

Our goal is to evolve ourbusiness from one which resells commodity IT products to one which providesvalue-added solutions to our government customers. A number of risks areinherent in this strategy. We may not be able to successfully transform ourworkforce into one which has the technical skills to provide more complextechnology to customers. Services and solutions require different internalaccounting, tracking, and project management procedures, and there is noassurance we will be able to 

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developand implement those necessary procedures. We will be competing againstorganizations which have greater experience and past performance in sellingsolutions to government customers. We will need to secure additional governmentcontracts which provide for us to sell service-only solutions, and thosecontracts are highly competed. And we will need to develop certain internaltechnical capabilities to identify, develop, market and sell more complexsolutions, and there is no assurance we will be successful in these endeavors.

***Compliance with changing regulations of corporategovernance and public disclosure may result in additional expenses.***

Changing laws, regulationsand standards relating to corporate governance and public disclosure, includingthe Sarbanes-Oxley Act of 2002, new SEC regulations and NASDAQ National Marketrules, are creating uncertainty for companies such as ours. These new orchanged laws, regulations and standards are subject to varying interpretations,in many cases due to their lack of specificity, and as a result theirapplication in practice may evolve over time as new guidance is provided byregulatory and governing bodies. This could result in higher costs necessitatedby ongoing revisions to disclosure and governance practices. As a result, ourefforts to comply with evolving laws, regulations and standards have resultedin, and are likely to continue to result in, increased selling, general andadministrative expense and a diversion of management’s time and attention fromrevenue-generating activities to compliance activities. In particular, ourefforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002 andthe related regulations regarding our required assessment of internal controlover financial reporting and our external auditors’ audit of that assessmentrequire the commitment of significant financial and managerial resources.Further, our Board members, Chief Executive Officer and Chief Financial Officercould face an increased risk of personal liability in connection with theperformance of their duties. As a result, we may have difficulty attracting andretaining qualified Board members and executive officers, which could harm ourbusiness.

***If we are unable to attract and retain talentedemployees, it could have a material adverse impact on our business and resultsof operations.***

Our success depends inlarge part on the continued services of our management and key employees. Theloss of the services of key personnel could have a material adverse impact onour operations. Our future success will also depend on our ability to attractand retain highly skilled personnel, including finance and accounting staff, toreplace personnel who leave. In addition to the low unemployment rate in theWashington, DC metropolitan area, competition for experienced management,finance professionals, and technical, sales and support personnel in the ITindustry is substantial. During the year ended December 31, 2005, ourannual voluntary turnover rate for total staff was approximately 30%. If wecontinue to experience the loss of a significant number of our employees in thefuture, it could adversely affect our operating results, including our abilityto obtain and successfully complete customer engagements or effectively compete.To attract and retain employees, we may have to increase our compensationlevels or incur higher recruiting costs in the future. This would adverselyaffect our financial performance.

***Our quarterly sales and cash flows are volatile, whichmakes our future financial results difficult to forecast.***

Our sales,operating results and cash flows have been, and are expected to continue to be,subject to significant fluctuations from quarter to quarter due to a number offactors including:

·       Theseasonality of our business due to the U.S. Federal Government’s buying andfunding patterns;

·       Fluctuationsin our gross margins due to variations in the mix of products sold and excessor obsolete inventory charges;

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·       Thenumber, size and scope of orders from our customers;

·       Demandfor our services generated by strategic partnerships and certain primecontractors;

·       Availabilityof price protection, purchase discounts and rebate programs from vendors;

·       Contractualterms and degree of completion of projects;

·       Changesin our sales cycles as we move towards solution selling; and

·       Changesin accounting rules, such as recording expenses for employee stock optiongrants and tax accounting principles.

Our recent level ofproduct gross margins may not be sustainable. In addition, changes in servicesgross margin may result from various factors such as changes in the mix betweentechnical support services and advanced services, as well as the timing ofservice contract initiations and renewals. As a consequence, sales volumes andoperating results for future periods are difficult to predict and, therefore,prior results are not necessarily indicative of results to be expected infuture periods.

***Because we sometimes work with third parties, anyfailure by these third parties to satisfactorily perform their obligationscould hurt our reputation, operating results and competitiveness.***

We offer certain of ourservices to our customers through various third-party service providers engagedto perform these services on our behalf. In addition, we outsource parts of ouroperations to third-parties and may continue to explore opportunities tooutsource others. In these engagements, we may engage subcontractors or we mayact as subcontractor to the prime contractor of an engagement. In the eventthese third parties fail to maintain adequate levels of support, do not providehigh quality services or cease or reduce operations, our business, operations,customer relations and sales may be negatively impacted and we may be requiredto pursue replacement third-party relationships, which we may not be able toobtain on as favorable terms or at all. In addition, the inability to negotiateterms of a contract with a third party, the refusal or inability of these thirdparties to permit continued use of their services by us, or the termination bythe client or prime contractor of our services or the services of a keysubcontractor would harm our operating results.

***Any issue that compromises our relationship with agenciesof the U.S. Federal Government would cause serious harm to our business.***

Our sales arehighly dependent on the government’s demand for IT products. Direct andindirect sales to numerous agencies and departments of the U.S. FederalGovernment accounted for 92%, 95% and 97% of our sales in 2005, 2004 and 2003,respectively. We believe that U.S. Federal Government contracts will continueto be a source of the majority of our sales for the foreseeable future. Forthis reason, any issue that compromises our relationship with agencies of theU.S. Federal Government would cause serious harm to our business. Although wedo not believe that the loss of any single agency or department would have amaterially adverse effect on our results of operations, a material decline inoverall sales to the U.S. Federal Government as a whole, or to certain keyagencies thereof, could have such an effect. Among the key factors inmaintaining our relationships with U.S. Federal Government agencies are:

·       ourperformance on individual contracts and delivery orders;

·       thestrength of our professional reputation;

·       therelationships of our key executives with customer personnel; and

·       ourcompliance with complex procurement laws and regulations related to theformation, administration and performance of U.S. Federal Government contracts.

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To the extent that our performance does not meetcustomer expectations, or our reputation or relationships deteriorate, thiswould cause a negative effect on our sales, profitability and cash flow.Noncompliance with government procurement regulations or contract provisionscould result in substantial monetary fines or damages, suspension or debarmentfrom doing business with the U.S. Federal Government, and civil or criminalliability.

Substantially all of ourgovernment contracts are terminable at any time at the government’s convenienceor upon default. If a government customer terminates one of our contracts forconvenience, we may recover, at most, only our incurred or committed costs,settlement expense, and profit on work completed prior to the termination. Upontermination of a government contract for default, the government reserves theright to recover the excess costs of procuring the specified goods and servicesfrom a different contractor although GTSI would reserve the right to appeal.The effect of unexpected contract terminations would negatively impact ourfinancial results.

***Our markets are highly competitive; if we do notcompete effectively, we could face continued operating losses and loss ofmarket share.***

The information technology markets are highlycompetitive and are served by numerous international, national and local firms.We may not be able to compete effectively in these markets. Market participantsinclude traditional hardware and software resellers, systems integrators,commercial computer retail chains and distributors. Some of these competitorshave significantly greater financial, technical and marketing resources,generate greater sales and have greater name recognition than we do. Inaddition, there are relatively low barriers to entry into the IT market, and wehave faced, and expect to continue to face, additional competition from newentrants into the IT market.

We believe ourability to compete also depends in part on a number of competitive factors,including:

·       Expertisein government procurement processes where standardized contracts exist;

·       Existingcustomer and vendor relationships (for which there is traditionally a highbarrier to entry);

·       Technicalexpertise;

·       Logisticalcapability;

·       theability of our clients or competitors to hire and retain project managers andother senior technical staff;

·       theprice at which others offer comparable technical solutions; and

·       theextent of our competitors’ responsiveness to client needs.

If we are unable tocompete effectively we could experience continued operating losses and ourmarket share may decline, adversely affecting our results of operations andfinancial condition.

***We may not qualifyas a small business for new contract awards.***

GTSI maintains a “small business” status under its GSASchedule contract, ITES contract and several BPAs it held in 2005 based uponits size status at the time of the contracts’ original award date. As a smallbusiness, GTSI enjoys a number of benefits, including being able to compete forsmall business orders, qualifying as a small business subcontractor, biddingpursuant to small purchase procedures directed to non-manufacturer smallbusiness, and offering government agencies an avenue to meet their internalsmall business purchase goals.

A company’s size statusunder a contract is based on the North American Industry Classification System(“NAICS”) Code referenced in the subject contract’s solicitation. Dependent onthe NAICS Code 

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referencedin a solicitation, GTSI may or may not qualify as a small business for newcontract awards. Under aFederal Acquisition Regulation (FAR) Deviation issued on October 10, 2002by GSA, GTSI will be required to recertify its size status on its GSA ScheduleContract no later than 2007. At such time, GTSI may not qualify as a smallbusiness for new orders under the GSA Schedule. In addition, new legislation orregulations may require GTSI to recertify its size status on its GSA Schedulesooner than 2007. We cannot predict whether we would continue to qualify as asmall business at the time of recertification.

***Adverse changes in U.S. Federal Government fiscalspending could have a negative effect on our sales, gross margin, and cashflow.***

Changes in U.S. FederalGovernment spending policies or budget priorities could directly affect ourfinancial performance. Among the factors that could materially harm ourbusiness are:

·       asignificant decline in spending by the U.S. Federal Government in general or byspecific departments or agencies in particular;

·       changesin the structure, composition and/or buying patterns of the U.S. FederalGovernment;

·       theadoption of new laws or regulations changing procurement practices; or

·       delaysin the payment of our invoices by government payment offices.

The U.S. FederalGovernment’s overall information technology spending for the 2007 fiscal yearwas announced to be $64 billion. This represents an increase of 2.8% overfiscal year 2006, a significant reduction over the five to six percentincreases received in recent years. These or other factors could cause U.S.Federal Government agencies and departments to reduce their purchases undercontracts, to exercise their right to terminate contracts, or not to exerciseoptions to renew contracts, any of which would cause us to lose future revenue.

***Any potential future acquisitions, strategicinvestments or mergers may subject us to significant risks, any of which couldharm our business.***

Our long-termstrategy may include identifying and acquiring, investing in or merging withsuitable candidates on acceptable terms. In particular, over time, we mayacquire, make investments in, or merge with providers of product offerings thatcomplement our business. Acquisitions include a number of risks and presentfinancial, managerial and operational challenges, including:

·       diversionof management attention from running our existing business;

·       possibleadditional material weaknesses in internal control over financial reporting;

·       increasedexpenses including legal, administrative and compensation expenses related tonewly hired employees;

·       increasedcosts to integrate the technology, personnel, customer base and businesspractices of the acquired company with our own;

·       potentialexposure to material liabilities not discovered in the due diligence process;

·       potentialadverse effects on our reported operating results due to possible write-down ofgoodwill and other intangible assets associated with acquisitions; and

·       acquisitionfinancing may not be available on reasonable terms or at all.

Any acquired business,technology, service or product could significantly under-perform relative toour expectations, and we may not achieve the benefits we expect from ouracquisitions. For all these 

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reasons,our pursuit of an acquisition, investment or merger could cause our actualresults to differ materially from those anticipated.

**ITEM 1B.**       UNRESOLVEDSTAFF COMMENTS

Not applicable.

**ITEM 2.**                PROPERTIES

GTSI’s primary business is conducted from a headquartersand distribution center located in Northern Virginia. We do not own any realproperty. Our headquarters are located in office space of approximately 165,000square feet in Chantilly, Virginia under long-term leases with varyingexpiration dates through 2011. GTSI’s primary distribution and integrationoperations are located in a facility of approximately 140,000 square-feet inChantilly, Virginia under a lease expiring in December 2011.

As a result of ourworkforce realignment activities taken in 2006, we currently have facilities inexcess of our needs. In 2006 we plan to consolidate our office locations andsublease one facility. Webelieve the facilities we are retaining are in good condition and suitable tomeet our current needs for the conduct of our business. For additionalinformation regarding our obligations under leases, see Note 13 of theconsolidated financial statements in Part II, Item 8 of this Form 10-K.

**ITEM 3.**                LEGALPROCEEDINGS

In November 2003,GTSI was served with a $25 million lawsuit, with treble damages, related to analleged breach of contract due to the termination of Ichiban, Inc., aformer subcontractor. This suit was filed in Virginia Circuit Court in FairfaxCounty, Virginia and follows the Company’s earlier lawsuit against the formersubcontractor. The case was decided in the Company’s favor resulting in anaward of $1.4 million in attorneys’ fees and costs. The plaintiff filed anappeal in October 2005 which the Supreme Court of Virginia refused on February 17,2006. The plaintiff has filed a petition for a rehearing with the Supreme Courtof Virginia.

**ITEM 4.**                SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of securityholders during the fourth quarter of 2005.

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**PART II**

**ITEM 5.**                MARKETFOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES

The Annual Meeting ofStockholders is scheduled to be held at 8:30 a.m. on Tuesday, May 9,2006, at the Company’s headquarters located at 3901 Stonecroft Boulevard inChantilly, Virginia.

**Price Range ofCommon Stock**

GTSI’s common stock is traded on the NASDAQ NationalMarket under the symbol GTSI. On April 3, 2006, we received a staffdetermination letter from the NASDAQ National Market stating that because GTSIhas not filed this Annual Report on Form 10-K with the SEC, asrequired by Market Place Rule 4310(c)(14), GTSI’s common stock is subjectto delisting from the NASDAQ National Market. GTSI has requested a hearing withNASDAQ which should stay the delisting pending the determination of NASDAQ’shearing panel. While there is no assurance, we expect to avoid delisting of ourcommon stock from the NASDAQ National Market by the filing this Form 10-Kwith the SEC.

As of April 7,2006, there were 330 stockholders of record of the Company’s common stock. Thefollowing stock prices are the high and low sales prices of GTSI’s common stockduring the calendar quarters indicated.

| **Quarter** | ** ** | ** ** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------|------------|------------|------------|----------|------------|----------|------------|
| First       |       | $          | 11.13      |     | $          | 9.46     |       | $ | 14.52 |   | $ | 11.39 |   |
| Second      |       | $          | 10.10      |     | $          | 7.80     |       | $ | 12.63 |   | $ | 10.10 |   |
| Third       |       | $          | 8.49       |     | $          | 6.75     |       | $ | 11.54 |   | $ | 7.86 |   |
| Fourth      |       | $          | 8.80       |     | $          | 7.00     |       | $ | 11.12 |   | $ | 8.44 |   |

 

GTSI’s transfer agent isAmerican Stock Transfer & Trust Company, 59 Maiden Lane, New York, NY10038; telephone 1-866-668-6550.

**Dividends**

The Company has never paidany cash dividends and does not anticipate paying cash dividends on its commonstock in the foreseeable future. GTSI’s Credit Facility discussed under Part II,Item 8, Note 8 to the consolidated financial statements of this Annual Reporton Form 10-K prohibits the payment of dividends.

**Issuer Purchases ofEquity Securities**

GTSImade the following purchases of its common stock during the fourth quarter of2005:

| **Period**                                            | ** ** | ** ** | ** ** | **Total  Number of  Shares  Purchased** | ** ** | **Average  Price Paid  per Share** | ** ** | **Total  Number of  Shares  Purchased as  Part of Publicly  Announced  Program** | ** ** | **Approximate  Dollar Value   of Shares that  May Yet Be  Purchased  Under the  Program** | ** ** |
|-------------------------------------------------------|------------|------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------|------------|
| October 1 to  October 31, 2005              |       |       | 99,800     |                                         |       |                                         | $          | 7.52                                                                                                 |       |                                                                                                                         |       | 99,800 |   |   |   |   |   |   |
| November 1 to  November 30, 2005            |       |       | 79,600     |                                         |       |                                         | $          | 8.21                                                                                                 |       |                                                                                                                         |       | 79,600 |   |   |   |   |   |   |
| December 1  to December 31, 2005            |       |       | 56,400     |                                         |       |                                         | $          | 8.50                                                                                                 |       |                                                                                                                         |       | 56,400 |   |   |   |   |   |   |
| Total—Three Months Ended  December 31, 2005 |       |       | 235,800    |                                         |       |                                         | $          | 7.99                                                                                                 |       |                                                                                                                         |       | 235,800 |   |   |   | $ | 5,126,176 |   |   |
|                                                       |            |            |            |                                              |            |                                              |            |                                                                                                      |            |                                                                                                                              |            |  |  |  |  |  |  |  |  |  |  |

 

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GTSI’s common stock purchase program was announced in February 2000.GTSI’s Board of Directors authorized GTSI to repurchase its common stock for anaggregate purchase price up to $5.25 million. In January 2002 and April 2005,GTSI’s Board of Directors authorized additional purchases to increase theaggregate purchase amount to $10 million. This purchase program, as increased,is the only stock purchase program currently in effect and there have been norepurchase programs that have expired during the period covered by this report.

GTSI’s Credit Facilityalso includes restrictions on GTSI’s working capital as well aslimitations on the purchase of GTSI’s stock. Due to the terms of theCredit Agreement entered into as a result of events of default as of January 31,2006, the Company is currently restricted from purchasing its stock.

**Equity CompensationPlans**

Thefollowing table summarizes information regarding GTSI’s equity compensationplans as of December 31, 2005.

| **Plan Category**                                   | ** ** | ** ** | ** ** | **Number of Shares  to be Issued upon   Exercise of   Outstanding  Options  (a)** | ** ** | **Weighted Average  Exercise Price  of Outstanding   Options  (b)** | ** ** | **Number of Shares  Remaining Available   for Future Issuance  Under Equity  Compensation Plans  (excluding shares  reflected in column (a))  (c)** | ** ** |
|----------------------------------------------------------|------------|------------|------------|---------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity  compensation plans approved by stockholders      |       |       | 1,825,350  |                                                                                                                      |       |                                                                                    | $          | 8.3615                                                                                                                                                                                                          |       |   |   | 675,252 |   |   |
| Equity  compensation plans not approved by stockholders* |       |       | 263,000    |                                                                                                                      |       |                                                                                    | $          | 9.9930                                                                                                                                                                                                          |       |   |   | N/A |   |   |
| Total                                                    |       |       | 2,088,350  |                                                                                                                      |       |                                                                                    | $          | 8.5670                                                                                                                                                                                                          |       |   |   | 675,252 |   |   |

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*******                   ****Represents**sharesissuable under options granted from time to time to persons not previouslyemployed by the Company, as an inducement essential to such persons enteringinto employment agreements with the Company.

For a description of theother material features of the Company’s equity compensation plans, see Note 9of the notes to consolidated financial statements in Item 8 of this AnnualReport on Form 10-K.

**ITEM 6.**                SELECTEDFINANCIAL DATA

Thefollowing selected consolidated financial data as of and for the years ended December 31,2005, 2004, 2003, 2002 and 2001 has been derived from the consolidatedfinancial statements. This selected financial data should be read inconjunction with Management’s Discussion and Analysis of Financial Conditionand Results of Operations and our consolidated financial statements and relatednotes included in this Annual Report on Form 10-K. Our (loss) incomefrom operations, net (loss) income and (loss) earnings per share for the yearsended December 31, 2005 and 2004 were materially affected for certainitems, which affects the comparability of the information presented with otheryears’ results. Cost of Sales for the year ended December 31, 2004included the positive effects of the derecognition of aged accrued payables of$10.1 million and a change in estimate of vendor payable amounts of $2.5million as discussed in Note 1 to the consolidated financial statements. Thisresulted in an increase of $12.6 to Gross Margin and Income from Operations forthe year ended December 31, 2004. In addition, Cost of Sales for the yearended December 31, 2005 included the positive effects of the reversal of achange in estimate of vendor payable amounts of $2.6 million. These increaseswere offset by a $5.6 million charge recorded in Costs of Sales for excess andobsolete inventory to write-down inventory to its market value as discussed inNote 6 

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to the consolidated financial statements. All notesreferenced are in Item 8 of this Annual Report on Form 10-K.

**Statement of Operations Data:**

| ** **                                  | ** ** | **For the years ended December 31,**      | ** ** |
|---------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                  | ** ** | **2005**                                                           | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                  | ** ** | **(in thousands, except per share data)** | ** ** |
| Sales                                       |       | $                                                                  | 886,263    |   | $ | 1,076,148 |   | $ | 954,118 |   | $ | 934,730 |   | $ | 783,496 |   |
| Cost of sales                               |       | 791,346                                                            |       | 954,143 |   | 857,334 |   | 857,105 |   | 718,370 |   |
| Gross margin                                |       | 94,917                                                             |       | 122,005 |   | 96,784 |   | 77,625 |   | 65,126 |   |
| Operating  expenses:                        |       |                                                               |       |   |   |   |   |   |   |   |   |
| Selling, general  and administrative        |       | 115,201                                                            |       | 107,833 |   | 85,473 |   | 62,956 |   | 57,002 |   |
| Depreciation and  amortization              |       | 4,250                                                              |       | 3,022 |   | 2,874 |   | 3,543 |   | 4,407 |   |
| Impairment charge                           |       | 981                                                                |       | — |   | 5,972 |   | — |   | — |   |
| Total operating  expenses                   |       | 120,432                                                            |       | 110,855 |   | 94,319 |   | 66,499 |   | 61,409 |   |
| (Loss) income  from operations              |       | (25,515                                                            | )          | 11,150 |   | 2,465 |   | 11,126 |   | 3,717 |   |
| Interest and  other income, net             |       | 6,729                                                              |       | 5,569 |   | 2,832 |   | 4,520 |   | 3,707 |   |
| (Loss) income  before income taxes          |       | (18,786                                                            | )          | 16,719 |   | 5,297 |   | 15,646 |   | 7,424 |   |
| Income tax  benefit (provision)             |       | 2,787                                                              |       | (6,455 | ) | (2,118 | ) | (6,113 | ) | (2,938 | ) |
| Net (loss) income                           |       | $                                                                  | (15,999    | ) | $ | 10,264 |   | $ | 3,179 |   | $ | 9,533 |   | $ | 4,486 |   |
| (Loss) earnings  per common share           |       |                                                               |       |   |   |   |   |   |   |   |   |
| Basic                                       |       | $                                                                  | (1.74      | ) | $ | 1.18 |   | $ | 0.38 |   | $ | 1.15 |   | $ | 0.55 |   |
| Diluted                                     |       | $                                                                  | (1.74      | ) | $ | 1.09 |   | $ | 0.35 |   | $ | 1.04 |   | $ | 0.50 |   |
| Weighted average  common shares outstanding |       |                                                               |       |   |   |   |   |   |   |   |   |
| Basic                                       |       | 9,177                                                              |       | 8,664 |   | 8,349 |   | 8,302 |   | 8,144 |   |
| Diluted                                     |       | 9,177                                                              |       | 9,388 |   | 9,116 |   | 9,156 |   | 9,049 |   |

 

**Balance Sheet Data:**

| ** **                        | ** ** | **As of December 31,** | ** ** |
|-----------------------------------|------------|---------------------------------------|------------|
| ** **                        | ** ** | **2005**                              | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                        | ** ** | **(in thousands)**               | ** ** |
| Working capital                   |       | $                                     | 60,560     |   | $ | 79,027 |   | $ | 64,348 |   | $ | 62,836 |   | $ | 34,968 |   |
| Total assets                      |       | $                                     | 306,657    |   | $ | 296,386 |   | $ | 268,761 |   | $ | 224,918 |   | $ | 252,452 |   |
| Borrowings under  credit facility |       | $                                     | 48,014     |   | $ | 1,179 |   | $ | 12,813 |   | $ | 7,539 |   | $ | 20,186 |   |
| Long-term  liabilities            |       | $                                     | 3,922      |   | $ | 3,473 |   | $ | 1,522 |   | $ | 1,640 |   | $ | 2,403 |   |
| Total liabilities                 |       | $                                     | 231,963    |   | $ | 204,249 |   | $ | 190,816 |   | $ | 149,427 |   | $ | 189,387 |   |
| Stockholders’ equity         |       | $                                     | 74,694     |   | $ | 92,137 |   | $ | 77,945 |   | $ | 75,491 |   | $ | 63,065 |   |

 

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**ITEM 7.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussionand analysis is provided to increase the understanding of, and should be readin conjunction with, our audited consolidated financial statements and notesincluded in Part II, Item 8 of this Annual Report on Form 10-K.Historical results and percentage relationships among any amounts in theconsolidated financial statements are not necessarily indicative of trends inoperating results for any future period. We use the terms “GTSI,” “we,” “our,”and “us” to refer to GTSI Corp. and its subsidiaries.

**Restatement**

As more fully described inNote 3 of the consolidated financial statements of this Annual Report on Form 10-K,the Company has restated its consolidated balance sheets and statements ofoperations for the quarters ended March 31, 2005, June 30, 2005, and September 30,2005 primarily to correct the accounting for revenue recognition and inventoryvaluation in the proper quarter. All accounting information included inManagement’s Discussion and Analysis of Financial Condition and Results ofOperations reflect the restatement.

**Going Concern**

Our independent registered public accounting firm,Ernst & Young LLP, has concluded that substantial doubt exists aboutour ability to continue as a going concern, and has included that conclusion inits audit report on our consolidated financial statements for the year ended December 31,2005 included in this Annual Report on Form 10-K. We incurred a netloss of $16.0 million and used $42.0 million in cash for operating activitiesfor the year ended December 31, 2005. In addition, we have not compliedwith certain covenants of our Credit Facility as of January 31, 2006. Abreach of any of the covenants or restrictions contained in the Credit Facilitywould result in an event of default. Such a default could allow the lenders todiscontinue lending or declare all borrowings outstanding to be due and payable.If any of these events occur, there is no assurance that we will havesufficient funds available to pay in full the total amount of obligations thatbecome due as a result of any such acceleration, or that we will be able tofind additional or alternative financing to refinance any such accelerated obligations.Our lenders have notified us that our Credit Facility will terminate on theannual renewal date of May 31, 2006. As a result, we will need areplacement credit facility to meet our capital needs for the remainder of 2006and beyond.

In the absence ofreceiving a credit facility, management does not believe that our existingcapital resources will enable us to fund operations for the next three months.Management plans to obtain alternative financing under a revolving creditfacility with new lenders prior to the expiration of our Credit Facility. Wedid not include any adjustments to the consolidated financial statementsincluded in this Form 10-K to reflect the possible future effectsthat may result from the uncertainty of our ability to continue as a goingconcern because we are confident that we will continue to be a financiallysound and viable business, providing quality service to our governmentcustomers, attractive employment opportunities for our employees and long-termvalue to our stockholders. We expect to obtain a replacement credit facility inthe near future and we are taking the necessary actions to improve our cashflows. We are currently undertaking the following efforts to address thisuncertainty:

·       OnApril 10, 2006 we signed a commitment letter to negotiate a new revolvingcredit facility with two major money center banks by May 31, 2006, theexpiration date of the current Credit Facility;

·       Weare working to strengthen the core operating processes of the supply chain andimprove productivity;

·       Wehave concerted efforts underway to improve working capital by collected agedreceivables, increase the amount of partial billings and invoice customers assoon as allowed; and

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·       Weinitiated significant reductions in workforce in October 2005 and February 2006to reduce our costs, eliminating over 100 full time positions.

In the fourth quarter of2005, we developed a strategic multi-element plan to identify and exit failingor non-strategic activities, improve execution of the current business, andemerge as a high value solutions-provider. While we are confident in our plans for 2006,we recognize the challenges we face in winning new contracts, winningre-competes of existing contracts, and satisfying our customers and vendors. Webelieve that our strategic plan will create positive momentum and help usreturn to profitability.

**Overview**

GTSI has more than 20 yearsof experience in selling IT products and solutions primarily to U.S. FederalGovernment customers. We believe our key differentiators to be ourstrong brand among government customers, extensive contract portfolio and widevariety of vendors.

The vast majority of the IT solutions we offer to ourcustomers have a strong product component, and many are entirely product-based.We connect IT’s leadingvendors, products and services inside the core technology areas most criticalto government success by partnering with global IT leaders such as Panasonic,HP, Cisco, Sun Microsystems and Microsoft. In our traditional resellercapacity, we provide government with products for workgroup computing, such asworkstations and desktops; mobility computing and communications, such aswireless-equipped notebooks and PDAs; core computing, such as servers, high-endcomputing, and storage systems; networking products; and a wide range ofperipherals.

During 2005, we began focusing on application areas inwhich our government customers have consistently demonstrated the greatestimmediate strategic interest, and which provide us with the greatest opportunityfor sustained return on investment. Our primary solution attention is beingdirected toward IT consolidation, disaster recovery and backup, e-mailmanagement, and visual communication support for remote workers and distributedoffices, including collaboration, presentation, and broadcast systems.

To help our customers acquire, manage and refresh thistechnology in a strategic and application-appropriate manner, GTSI has createda mix of financial services capable of managing the entire technology lifecycle.GTSI offers leasing arrangements to allow government agencies to acquire accessto technology as an evenly distributed operating expense, rather than the muchmore budget-sensitive and discontinuous capital expenses. This model is in highdemand from our customers, and we believe it represents a distinctiveadvantage. We expect to continue to expand our sales from leasing arrangementsfor IT products and solutions in 2006.

In April of 2005, GTSI went live with a newsupply chain management system based on software provided by PeoplesoftCorporation, the GTSI Enterprise Management System (“GEMS”). Management hadplanned extensively for this implementation, and had invested a considerablesum of money training associates from a variety of functional disciplinesthroughout the supply chain.

For the first 90 days after go-live, we encounteredmany significant issues in every area of the supply chain. These issuesresulted in significant productivity issues that we spent the rest of the yearrecovering from. Dozens of bug fixes and patches to the software were required.While the software was operating significantly better after the first 90 days,many core processes were not fully stabilized and were not as efficient as withthe previous system. For the remainder of the year, a significant number ofenhancements and additional reporting capabilities were added which enabledmanagement to make better decisions based on the information available. As of December 31,2005, core processes were stabilized with many active programs underway tocontinue to improve core processes during 2006.

As discussed inmore detail in our MD&A:

·       Oursales decreased approximately $190 million, or 18%, from 2004 to 2005;

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·       Ourlease sales increased $32.5 million from 2004 to 2005, resulting in an increasein lease-related interest income of $2.2 million;

·       Werecorded a $5.6 million charge for inventory valuation at the lower of cost ormarket;

·       Ournet loss for the year ended December 31, 2005 was $16.0 million;

·       Cashused in operations totaled approximately $42 million;

·       Werecorded prior period adjustments to our previously issued 2005 quarterlyfinancial statements; however,

·       Ourbalance sheet remains solid, with no long-term debt.

We are looking forward tosignificant improvements in operational and financial performance through acombination of additional sales and improved margin percentages. We have put inplace a multi-element plan to move the business from lower margin product salesto higher margin solutions sales. In the first element of our plan, weidentified and exited failing or non-strategic activities, including tworeductions in workforce totaling over 100 full time positions and realigningfunctions throughout the Company to increase margin improvement through costreductions. In the second and third elements of our plan, which will progressthroughout 2006, we will work to improve execution of the current business anddeliver high value solutions. We believe there are significant opportunities toincrease our relatively low market share within the growing government ITmarket as we pursue a distinctive business model combining the concepts of avalue added provider of complex IT solutions with a traditional reseller.

**Critical AccountingEstimates and Policies**

The discussion and analysis of our financial conditionand results of operations is based on our consolidated financial statements,which have been prepared in accordance with U.S. generally accepted accountingprinciples. The preparation of these financial statements requires managementto make estimates, judgments and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the consolidated financial statements and the reported amountsof revenue and expenses during the reporting period. Actual results may differfrom these estimates under different assumptions or conditions. Criticalaccounting estimates are defined as those that are reflective of significantjudgments and uncertainties, and potentially result in materially differentresults under different assumptions and conditions. We have included below ourpolicies that are both important to our financial condition and operatingresults, and require management’s most subjective and complex judgments indetermining the underlying estimates and assumptions.

The following list ofcritical accounting estimates and policies is not intended to be acomprehensive list of all of our accounting policies. Our significantaccounting policies are more fully described in Note 1 to our consolidatedfinancial statements in Item 8 of this Annual Report on Form 10-K.Accounting policies and estimates that management believes are most importantto our financial condition and require management’s significant judgments andestimates pertain to revenue recognition, valuation of inventory, capitalizedinternal use software, accounts payable and income taxes. We have discussed theapplication of these critical accounting estimates with the Audit Committee ofour Board of Directors.

*Revenue Recognition*

We recognize revenue when persuasive evidence of asale arrangement exists, delivery has occurred or services have been rendered,the sales price is fixed or determinable, and collectibility is reasonablyassured. The majority of our sales relates to physical products and isgenerally recognized when title and risk of loss to the products sold passes tothe customer. Based on our standard shipping terms, title generally passes uponthe customer’s receipt of the products. This requires us to analyze sales nearthe end 

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of reporting periods toestimate the amount of products in transit to the customer that cannot berecognized as revenue. Many of our sales of physical products are shipped toour customers directly from our vendor partners. The accurate recording ofrevenue for these transactions relies upon the accuracy of shipment dates wereceive from our vendors and is subject to additional estimates and judgmentsby management.

When a customer order contains multiple items such ashardware, software, and services that are delivered at varying times,significant judgment is required to determine whether the delivered items canbe considered separate units of accounting and if so, how the price should beallocated among the deliverable elements and when to recognize revenue for eachelement.

Certain of our service and solution agreements requiresignificant revenue recognition estimates including progress towards completionand total estimated costs to complete. Revenues on professional servicecontracts are generally recognized using the proportional-performance basis ofaccounting. For some professional services engagements, services to beperformed in the last series of acts is so significant in relation to theentire service contract that performance is deemed not to have occurred untilthe final act is completed, or there are customer-specified subjectiveacceptance criteria; the completed-performance method is used.

At the time of sale, werecord an estimate for product returns based on historical experience.Management reviews the assumptions regarding the lag time and volume of salesreturns at least on a quarterly basis, and changes in the estimates arerecorded in the period in which they occur.

*Inventory*

Our inventory is stated at the lower of average costor market value. We reduce the value of our inventory for excess and obsoleteinventory based on assumptions about future demand and market conditions. Ourestimates of future product demand may prove to be inaccurate, in which case wemay have understated or overstated the provision required for excess orobsolete inventory. In the future, if there were a higher incidence ofinventory obsolescence because of rapidly changing technology and customerrequirements, we would be required to increase our expense to write-downinventory to market value and our Gross Margin could be adversely affected.

During 2005, due to thedifficulties arising from the implementation of GEMS including ordering excessinventory and distraction of personnel from the management of procurement andinventory, we recorded an impairment charge of $5.6 million for obsolete andexcess inventory, which reduced our Gross Margin by the same amount. During2004 as a result of our physical inventory counts and other internal controls,we discovered two instances of inventory losses which resulted in a charge toCost of Sales of $0.7 million, net of insurance settlement.

*CapitalizedInternal Use Software*

Significant judgment is required to determine whatexpenditures qualify for capitalization of internal use software. Subsequentadditions, modifications or upgrades to internal-use software are capitalizedonly to the extent that they allow the software to perform a task that itpreviously did not perform. Capitalized internal use software is required to be tested forrecoverability whenever events or changes in circumstances indicate that theircarrying amount may not be recoverable. If the carrying value exceedsthe undiscounted cash flows expected toresult from the use and eventual disposition of the asset, an impairment chargeis recognized.

During the year ended December 31,2005 management decided to use a web-based customer resource management (“CRM”)software instead of the CRM module of GEMS. As a result, we tested certainasset groupings within GEMS for recoverability and recorded an impairment lossof approximately 

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$1.0million, net of accumulated amortization, in operating expenses to write downGEMS to its fair value. During the year ended December 31, 2003 we changedour strategy regarding GEMS from a highly customized enterprise resourceplanning (“ERP”) system to a standard ERP system to compress the delivery timeand provide significant value sooner. Due to this change in strategy, werecorded an impairment charge of approximately $6.0 million for capitalizedcustomization expenses determined to have no future economic value. If anyfuture events indicate the carrying amount of GEMS may exceed its fair value,we will test for recoverability which would necessitate the use of significantassumptions regarding the fair value and undiscounted net cash flows expected.During the years ended December 31, 2005 and 2004, we capitalized $2.1million and $5.5 million for GEMS. As of December 31, 2005 and 2004 thecarrying value of GEMS was $9.1 million and $9.1 million, respectively.

*Accounts Payable*

We purchase significantamounts of inventory each year and record an estimate for inventory and therelated payable when inventory is received based on the purchase orders issuedas of the balance sheet date and the historic rate of purchase price variances,which is analyzed on a quarterly basis. As invoices are received, we recordadjustments for purchase price variances, which generally reduce Cost of Sales.Changes in our estimate of the payable balance may be caused by changes inprice between the order date and the receipt date related to volume discounts,changes in market rates, or special pricing promotions offered by our vendors.

*Income Taxes*

Determining our effective tax rate, provision for taxexpense, deferred tax assets and liabilities and the related valuation allowanceinvolves judgments and estimates. Deferred income taxes result from temporarydifferences between the tax basis of assets and liabilities and the basisreported in our consolidated financial statements. Deferred tax liabilities andassets are determined based on the difference between financial statement andtax basis of assets and liabilities using enacted rates expected to be ineffect during the year in which the differences reverse. Valuation allowancesare provided against assets, including net operating losses, if it isanticipated that the asset is not more likely than not to be realized throughfuture taxable earnings or implementation of tax planning strategies. We recordreserves for uncertain tax positions, which management believes are adequate.We recorded a valuation allowance during 2005 against the full amount of ournet deferred tax assets, because in the opinion of management, it is morelikely than not that these deferred tax assets will not be realized. Oureffective tax rate in a given period could be impacted if we determine theallowance is or is not required, or if we were required to pay amounts inexcess of established reserves. See Note 11 to the consolidated financialstatements.

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**Historical Resultsof Operations**

Thefollowing table illustrates the percentage of sales represented by items in ourconsolidated statements of operations for the years ended December 31:

| ** **                          | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Sales                               |       | 100.0    | %          | 100.0    | %          | 100.0    | %          |
| Cost of sales                       |       | 89.3     |       | 88.7     |       | 89.9     |       |
| Gross margin                        |       | 10.7     |       | 11.3     |       | 10.1     |       |
| Operating expenses:                 |       |     |       |     |       |     |       |
| Selling, general and administrative |       | 13.0     |       | 10.0     |       | 8.9      |       |
| Depreciation and amortization       |       | 0.5      |       | 0.3      |       | 0.3      |       |
| Impairment charge                   |       | 0.1      |       | -        |       | 0.6      |       |
| Total operating  expenses           |       | 13.6     |       | 10.3     |       | 9.8      |       |
| (Loss) income  from operations      |       | (2.9     | )          | 1.0      |       | 0.3      |       |
| Interest and  other income, net     |       | 0.8      |       | 0.6      |       | 0.3      |       |
| (Loss) income  before taxes         |       | (2.1     | )          | 1.6      |       | 0.6      |       |
| Income tax  benefit (provision)     |       | 0.3      |       | (0.6     | )          | (0.3     | )          |
| Net (loss) income                   |       | (1.8     | )%         | 1.0      | %          | 0.3      | %          |

 

The followingtable indicates, for the years ended December 31, the approximate sales byvendor and product category along with related percentages of total sales(dollars in millions).

| **Sales by Vendor** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Panasonic                     |       | $        | 179.7      |     | 20.3       | %        | $          | 188.0 |   | 17.5 | % | $ | 162.2 |   | 17.0 | % |
| HP                            |       | 84.1     |       | 9.5      |       | 153.4    |       | 14.3 |   | 139.3 |   | 14.6 |   |
| Cisco                         |       | 115.1    |       | 13.0     |       | 135.7    |       | 12.6 |   | 112.9 |   | 11.8 |   |
| Sun Microsystems              |       | 111.6    |       | 12.6     |       | 131.8    |       | 12.2 |   | 130.1 |   | 13.6 |   |
| Microsoft                     |       | 31.0     |       | 3.5      |       | 53.7     |       | 5.0 |   | 66.5 |   | 7.0 |   |
| Others, net of  reserves      |       | 364.8    |       | 41.1     |       | 413.5    |       | 38.4 |   | 343.1 |   | 36.0 |   |
| Total                         |       | $        | 886.3      |     | 100.0      | %        | $          | 1,076.1 |   | 100.0 | % | $ | 954.1 |   | 100.0 | % |

 

| **Sale by Type**           | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Hardware, net of  reserves           |       | $        | 677.7      |     | 76.5       | %        | $          | 834.1 |   | 77.5 | % | $ | 692.5 |   | 72.6 | % |
| Software                             |       | 141.6    |       | 16.0     |       | 155.7    |       | 14.5 |   | 154.5 |   | 16.2 |   |
| Resold  third-party service products |       | 48.9     |       | 5.5      |       | 66.6     |       | 6.2 |   | 91.2 |   | 9.5 |   |
| Services                             |       | 18.1     |       | 2.0      |       | 19.7     |       | 1.8 |   | 15.9 |   | 1.7 |   |
| Total                                |       | $        | 886.3      |     | 100.0      | %        | $          | 1,076.1 |   | 100.0 | % | $ | 954.1 |   | 100.0 | % |

 

**Year Ended December 31,2005 Compared with Year Ended December 31, 2004**

*Sales*

Sales consist of revenue from products delivered andservices sold or rendered, net of allowances for customer returns and credits.Sales decreased $189.9 million, or 17.6%, from $1.1 billion in 2004 to $886.3million in 2005. The majority of this decrease is due to fewer customer orders.While our total sales declined, we did see strong sales growth under ourleasing arrangements which increased $44.1 million from 2004 to 2005 as ourcustomers took increasing advantage of acquiring technology as an evenly distributedoperating expense instead of discontinuous capital expenditures.

An analysis of sales by type reveals year over yeardecreases for each type, most predominantly due to the $156.4 million declinein hardware sales to $677.7 million in 2005.

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Although we offer our customers access to productsfrom hundreds of vendors, 58.9% of our sales in 2005 were products from our topfive vendors. As detailed in the preceding table, Panasonic remains our topvendor with product sales of $179.7 million in 2005. Sales from the top fivevendors in 2005 decreased by $141.1 million, or 21.3%, as compared to December 31,2004.

GTSI will be required torecertify our “small business” size status on our GSA Schedule Contract nolater than 2007. At such time, we may not qualify as a small business. Tomitigate any potential adverse affect on our sales from the loss of our smallbusiness status, GTSI has developed strategic relationships with smallbusinesses that benefit from the small business benefits described in the Businesssection in Part I of this Form 10-K. GTSI acts as both asupplier and prime contractor to these small businesses. In addition, wefurther mitigate this risk by participating in the Mentor-Protégé Programoffered under the SBAs 8(a) program, which is a business developmentinitiative that helps socially and economically disadvantaged Americans gainaccess to economic opportunity.

*Gross Margin*

Gross Margin decreased$27.1 million, or 22.2%, from $122.0 million in 2004. Gross margin as apercentage of sales decreased from 11.3% in 2004 to 10.7% in 2005. In 2005, a$5.6 million charge for excess and obsolete inventory negatively impacted GrossMargin. In addition, Gross Margin was positively affected in 2005 and 2004 by$2.5 million and $2.6 million, respectively, for the change in estimate ofamounts payable. In 2004, a $10.1 million non-cash extinguishment of agedvendor liabilities positively impacted Gross Margin. Gross Margin excludingthese adjustments was 10.2% in 2004 and 11.1% in 2005.

*Selling, General &Administrative Expenses*

Selling, General &Administrative (“SG&A”) expenses for 2005 increased $7.4 million, or 6.8%from 2004. This increase was primarily related to compensation and benefitsexpense associated with our long-term investments in new employees to increasesales and take advantage of the robust government marketplace. Given the weaksales and margin performance during 2005, and the strains on the organizationassociated with the GEMS implementations, we implemented two separatereductions in our workforce, one in October 2005 and one in February 2006.As a result of these activities, our workforce is now at comparable levels towhere it had been in 2003 and the first half of 2004. Total SG&A expensesincreased 3.0 percentage points as a percentage of sales from 2004 to 2005.

*Impairment Charge*

During 2005 we decided touse a web-based customer resource management (“CRM”) software instead of theCRM module of GEMS. As a result, we tested certain asset groupings within GEMSfor recoverability and recorded an impairment loss of approximately $1.0million, net of accumulated amortization, in operating expenses to write downGEMS to its fair value as required by SFAS No. 144 “Accounting for the Impairmentor Disposal of Long-Lived Assets,” (“FAS 144”).

*Interest and OtherIncome, Net*

Interest and Other Income,Net increased $1.2 million, or 20.8%, from 2004 to 2005. This increase ismainly due to an increase in interest income from the sales of our leasesreceivable. This increased income was partially offset by higher interestexpense on our Credit Facility due to increased borrowings as a result ofworking capital management issues, and due to higher interest rates.

*Income Taxes*

We recorded a tax benefitof $2.8 million, or 14.6%, for 2005 as compared to a tax provision of$6.5 million at an effective rate of 38.6% for 2004. The decrease in oureffective tax rate from 2004 to 2005 

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is dueto a full valuation allowance on our net deferred tax assets that we recordedduring the fourth quarter of 2005, and due to our loss before income taxes of$18.8 million. As a result, our income tax benefit for 2005 solely consists ofour tax refund that we will be receiving as a result of carrying back ourpre-tax loss to the amounts paid in 2003 and 2004.

**Year Ended December 31,2004 Compared with Year Ended December 31, 2003**

*Sales*

Sales consist of revenue from products delivered andservices sold or rendered, net of allowances for customer returns and credits.Sales increased $122.0 million, or 12.8%, from $954.1 million in 2003 to$1.1 billion in 2004. An analysis of sales by product reveals our overallsales increase was due to the $141.6 million rise in hardware to $834.1million in 2004 generated by increased sales of networking products, storageproducts and large server sales. This increase was partially offset by a $24.6million decline in sales of resold third-party service products. Sales ofservices increased 23.9% from 2003 to 2004 to $19.7 million.

Although we offer ourcustomers access to products from hundreds of vendors, 61.6% of our sales in2004 were products from our top five vendors. As detailed in the precedingtable, Panasonic remains our top vendor with product sales increasing $25.8million from 2003 to 2004. Sales of Cisco and HP products also increased $22.8million and $14.1 million, respectively, from the previous year. The increasein sales was also related to the $16.0 million decrease in backlog as of December 31,2004 compared to 2003.

*Gross Margin*

Gross Margin increased$25.2 million, or 26.1%, from $96.8 million in 2003 to $122.0 million in 2004.Gross margin as a percentage of sales increased from 10.1% for 2003 to 11.3% in2004. This increase was predominantly due to the reduction in Cost of Salesresulting from the $10.1 million non-cash extinguishment of aged vendorliabilities. Without the impact of this extinguishment, gross margin would havebeen 10.4% as a percentage of sales.

*Selling, General &Administrative Expenses*

SG&A expenses for 2004 increased $22.5 million, or25.5% from 2003. This increase was primarily related to approximately $6.9million in compensation and benefits expense from the company-wide headcountincrease and $6.1 million of additional commissions and commission acceleratorspaid on our increased sales.

In addition, we incurredexpenses of $2.0 million in consulting fees for our Sarbanes-Oxley (“SOX”)compliance and approximately $1.7 million for continued implementation of ourERP system.

*Impairment Charge*

In the fourthquarter of 2003 we changed our strategy regarding GEMS from a highly customizedenterprise resource planning (“ERP”) system to a standard ERP system because wedetermined that it was not in our best interest to continue to pursue a highlycustomized ERP solution due to the high level of development risk and thehigher total cost of ownership associated with maintaining a customizedsolution. We decided to implement a standard ERP system that is expected tolower the risk, compress the delivery time, provide significant value sooner,and reduce overall project expenses. Due to this change in strategy, werecorded an impairment charge of $6.0 million for capitalized customizationexpenses determined to have no future economic value.

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*Interest and OtherIncome, Net*

Interest and Other Income,Net increased $2.7 million, or 96.6%, from 2003 to 2004. This increase ismainly due to $3.2 million increase in interest income from the sales of ourleases receivable. This increased income was partially offset by the continuingdecline in prompt payment discounts received from vendors. Due to the economy,fewer vendors are offering this incentive. Interest and other expense remainedflat year over year.

*Income Taxes*

We recorded a taxprovision of $6.5 million for 2004, of which $3.9 million is due to thereversal of aged accrued liabilities, based on our expected annual effectivetax rate of approximately 38.6%. For 2003 we recorded a tax provision of $2.1million at an effective rate of 40.0%. The decrease in our effective tax ratefrom 2003 to 2004 is due to reduced state income taxes and a reduction inpermanent non-deductible items as a percentage of earnings before taxes. Themain difference between our effective tax rate in 2004 and the statutory rate isstate income taxes.

**SeasonalFluctuations**

We have historically experienced and expect tocontinue to experience significant seasonal fluctuations in our operations as aresult of the U.S. Federal Government buying and funding patterns. Theunpredictability of the factors affecting such seasonality makes our annual andquarterly financial results difficult to predict and subject to significantfluctuation. While sales to the U.S. Federal Government are usually weaker inthe first and second quarter and stronger in the third and fourth quarter, ourSelling, General & Administrative expenses are more level throughoutthe year. As such, first and second quarter earnings are typically well belowthose of the third and fourth quarters. Our stock price could be adverselyaffected if any such financial results fail to meet the financial community’sexpectations.

Thefollowing tables show our results of operations on a quarterly basis(unaudited). The first three quarters of the year ended December 31, 2005have been restated as described more completely in Note 3 to the consolidatedfinancial statements. We believe that this information includes all adjustmentsnecessary for a fair presentation of such quarterly information when read inconjunction with the notes to consolidated financial statements included inItem 8 of this Annual Report on Form 10-K. The operating results forany quarter are not necessarily indicative of the results for any future period.This information has been included to provide additional insight into theseasonal nature of our business.

| ** **                         | ** ** | **2005**                                                         | ** ** |
|------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                         | ** ** | **Q1  (restated)**                                               | ** ** | **Q2  (restated)** | ** ** | **Q3  (restated)** | ** ** | **Q4** | ** ** | **Total** | ** ** |
| ** **                         | ** ** | **(in millions except per share data)** | ** ** |
| Sales                              |       |                                                             | $          | 160.7 |   |   |   | $ | 176.5 |   |   |   | $ | 269.9 |   |   | $ | 279.2 |   | $ | 886.3 |   |
| Cost of sales                      |       |                                                             | 142.2      |   |   |   | 160.6 |   |   |   | 237.8 |   |   | 250.8 |   | 791.4 |   |
| Gross margin                       |       |                                                             | 18.5       |   |   |   | 15.9 |   |   |   | 32.1 |   |   | 28.4 |   | 94.9 |   |
| SG&A expenses                  |       |                                                             | 28.3       |   |   |   | 28.4 |   |   |   | 31.9 |   |   | 31.8 |   | 120.4 |   |
| (Loss) income  from operations     |       |                                                             | (9.8       | ) |   |   | (12.5 | ) |   |   | 0.2 |   |   | (3.4 | ) | (25.5 | ) |
| Interest and  other income, net    |       |                                                             | 0.7        |   |   |   | 0.4 |   |   |   | 4.3 |   |   | 1.4 |   | 6.7 |   |
| (Loss) income  before taxes        |       |                                                             | (9.1       | ) |   |   | (12.1 | ) |   |   | 4.5 |   |   | (2.0 | ) | (18.8 | ) |
| Income tax  benefit (provision)    |       |                                                             | 3.6        |   |   |   | 4.4 |   |   |   | (1.6 | ) |   | (3.6 | ) | 2.8 |   |
| Net (loss) income                  |       |                                                             | $          | (5.5 | ) |   |   | $ | (7.7 | ) |   |   | $ | 2.9 |   |   | $ | (5.6 | ) | $ | (16.0 | ) |
| Basic (loss) earnings per share    |       |                                                             | $          | (0.61 | ) |   |   | $ | (0.84 | ) |   |   | $ | 0.31 |   |   | $ | (0.61 | ) | $ | (1.74 | ) |
| Diluted (loss) earnings  per share |       |                                                             | $          | (0.61 | ) |   |   | $ | (0.84 | ) |   |   | $ | 0.30 |   |   | $ | (0.61 | ) | $ | (1.74 | ) |

 

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| ** **                         | ** ** | **2004**                                                         | ** ** |
|------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                         | ** ** | **Q1**                                                           | ** ** | **Q2** | ** ** | **Q3** | ** ** | **Q4** | ** ** | **Total** | ** ** |
| ** **                         | ** ** | **(in millions except per share data)** | ** ** |
| Sales                              |       |                                                             | $          | 178.6 |   |   |   | $ | 239.0 |   |   |   | $ | 330.6 |   |   | $ | 327.9 |   | $ | 1,076.1 |   |
| Cost of sales                      |       |                                                             | 160.5      |   |   |   | 217.5 |   |   |   | 283.9 |   |   | 292.2 |   | 954.1 |   |
| Gross margin                       |       |                                                             | 18.1       |   |   |   | 21.5 |   |   |   | 46.7 |   |   | 35.7 |   | 122.0 |   |
| SG&A expenses                  |       |                                                             | 21.7       |   |   |   | 24.6 |   |   |   | 30.4 |   |   | 34.2 |   | 110.9 |   |
| (Loss) income  from operations     |       |                                                             | (3.6       | ) |   |   | (3.1 | ) |   |   | 16.3 |   |   | 1.5 |   | 11.1 |   |
| Interest and  other income, net    |       |                                                             | 1.3        |   |   |   | 0.5 |   |   |   | 1.0 |   |   | 2.8 |   | 5.6 |   |
| (Loss) income  before taxes        |       |                                                             | (2.3       | ) |   |   | (2.6 | ) |   |   | 17.3 |   |   | 4.3 |   | 16.7 |   |
| Income tax  benefit (provision)    |       |                                                             | 0.9        |   |   |   | 1.0 |   |   |   | (6.8 | ) |   | (1.5 | ) | (6.4 | ) |
| Net (loss) income                  |       |                                                             | $          | (1.4 | ) |   |   | $ | (1.6 | ) |   |   | $ | 10.5 |   |   | $ | 2.8 |   | $ | 10.3 |   |
| Basic (loss) earnings per share    |       |                                                             | $          | (0.16 | ) |   |   | $ | (0.18 | ) |   |   | $ | 1.21 |   |   | $ | 0.31 |   | $ | 1.18 |   |
| Diluted (loss) earnings  per share |       |                                                             | $          | (0.16 | ) |   |   | $ | (0.18 | ) |   |   | $ | 1.13 |   |   | $ | 0.29 |   | $ | 1.09 |   |

 

**Liquidity andCapital Resources**

*Cash flows for the year ended December 31,*

| ** **                                       | ** ** | **2005**               | ** ** | **2004** | ** ** | **Increase/  (Decrease)** | ** ** |
|--------------------------------------------------|------------|------------------------|------------|----------|------------|---------------------------|------------|
| ** **                                       | ** ** | **(in millions)** | ** ** |
| Cash (used in)  provided by operating activities |       | $                      | (42.0      | )        | $          | 16.8                      |       |   | $ | 58.8 |   |   |
| Cash used in  investing activities               |       | $                      | (3.7       | )        | $          | (7.5                      | )          |   | $ | (3.8 | ) |   |
| Cash provided by (used  in) financing activities |       | $                      | 45.3       |     | $          | (9.1                      | )          |   | $ | 54.4 |   |   |

 

Cash used in operating activities for the year ended December 31,2005 was $42.0 million, a decrease of $58.8 million from cash provided byoperating activities for the year ended December 31, 2004. This decreasewas primarily due to significantly greater working capital needs as a result oflower sales and inefficiencies principally attributable to the implementationof GEMS in April 2005, which caused delays in billing and correspondingcash receipts from our customers. Total accounts receivable provided$27.3 million less to operations in 2005 compared to 2004. In late 2005,we implemented new processes related to cash management that we feel had, andwill continue to have, a positive impact on cash from operations during 2006.

Cash used in investing activities in 2005 was $3.8million less than cash used in 2004, and consisted principally of investmentsin GEMS during the early portion of the year. A much larger investment in GEMSoccurred during 2004.

Cash provided by financingactivities of $45.3 million during 2005 was due primarily to borrowings of$46.8 million under our revolving Credit Facility. Additionally, proceeds of$3.4 million from the exercise of employee stock options and employee stockpurchase plan activity were offset by borrowings of $4.9 million topurchase GTSI’s common stock.

*Credit Facility*

As of December 31, 2005 we had a $135 millionrevolving Credit Facility with a group of banks that expires on May 31,2006. The Credit Facility includes a revolving line of credit (the “Revolver”)and a provision for inventory financing of vendor products (the “WholesaleFinancing Facility”). Borrowing under the Revolver is limited to 85% ofeligible accounts receivable. The Revolver is secured by substantially all of ourassets. Borrowing under the Wholesale Financing Facility is limited to 100% ofthe value of our inventory and was $29.5 million as of December 31, 2005.The Wholesale Financing Facility is 

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secured by the underlyinginventory. The Credit Facility carried an interest rate indexed to the LondonInterbank Offered Rate (“LIBOR”) plus 1.75 percentage points as of December 31,2005. The Credit Facility also contains certain covenants as well as provisionsspecifying compliance with certain quarterly and annual financial ratios.

During the year ended December 31, 2005, wesigned four amendments to the Credit Facility to change the size of thefacility, add additional lenders to the syndicate, change certain debtcovenants, and extend the expiration date. During the year ended December 31,2004, we and our lenders signed three amendments to the Credit Facility to adda new lender and add our wholly owned subsidiaries, TLI and GTSI FinancialServices, as borrowers.

At December 31, 2005 and 2004, our interest rateunder the Credit Facility was 6.1% and 4.2%, respectively. The weighted averageinterest rates for the years ended December 31, 2005, 2004 and 2003 were5.1%, 3.2% and 3.0%, respectively.

We were in compliance withall financial covenants set forth in the Credit Facility as of December 31,2005. However, as of January 31, 2006 GTSI defaulted on the followingfinancial covenants under the Credit Facility: (i) maximum fundedindebtedness to EBITDA, (ii) minimum EBIT to net sales, and (iii) minimumtangible net worth. Our lenders requested the execution of an agreement totemporarily forbear them from enforcing their rights and remedies as a resultof the events of default. Subsequent to December 31, 2005, a forbearanceagreement (the “Credit Agreement”) was executed between GTSI and our lenders.See Note 15 for additional details and disclosure related to the CreditAgreement. On April 3, 2006, we defaulted on a covenant under the CreditAgreement when we received a staff determination letter from the NASDAQ NationalMarket stating that because we had not filed our Annual Report on Form 10-Kfor 2005 with the SEC, as required by Market Place Rule 4310(c)(14), GTSI’scommon stock is subject to delisting from the NASDAQ National Market. We haverequested a hearing with NASDAQ which should stay the delisting pending thedetermination of NASDAQ’s hearing panel. While there is no assurance, we expectto avoid delisting of our common stock from the NASDAQ National Market by thefiling of this Form 10-K. The Company had available credit of $41.2million at December 31, 2005 and $59.0 million at December 31, 2004.

*Capital Resourcesand Requirements*

Our ongoing capital requirements depend on a varietyof factors, including the extent to which we are able to fund the cash needs ofour business from operations. During 2005, we experienced significant workingcapital shortages as a result of our operational problems and lower salesvolumes, and relied upon vendor credit and borrowings under our Credit Facilityto fund our operations. We anticipate that we will continue to rely primarilyon vendor credit and a replacement credit facility to finance our operatingcash needs during the majority of 2006. We believe that such funds should besufficient to satisfy our near term anticipated cash requirements foroperations, assuming we are successful at structuring a new revolving creditfacility prior to the expiration of our existing Credit Facility on May 31,2006. We continue to have discussions with lenders related to structuring a newrevolving credit facility and on April 10, 2006 we signed a commitmentletter to negotiate a new revolving credit facility with two major money centerbanks by May 31, 2006, the expiration date of the current Credit Facility. Nonetheless, we may seek additionalsources of capital, including obtaining permanent financing over a longer termat fixed rates, to finance our working capital requirements or other strategicinitiatives. If we are unable to obtain alternative financing it would likelyhave a material adverse affect on our financial condition and ability tocontinue as a going concern.

During 2005 and 2004, we made capital expenditures of$3.7 million and $7.5 million, respectively, principally for capitalized costsassociated with the implementation of GEMS and the purchase of computersoftware for internal use.

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**Contractual Obligations**

| **(in millions)**            | ** ** | **Total** | ** ** | **Less Than  1 Year** | ** ** | **1-3  Years** | ** ** | **3-5  Years** | ** ** |
|-----------------------------------|------------|-----------|------------|---------------------------------|------------|----------------|------------|----------------|------------|
| Operating Lease  Obligations      |       | $         | 11.4       |                            |       | $              | 2.9        |           |       |   | $ | 6.9 |   |   |   | $ | 1.6 |   |   |
| Borrowings under  Credit Facility |       | 48.0      |       |                            | 48.0       |           |       |           | —     |   |   |   | — |   |   |
| Total Contractual  Obligations    |       | $         | 59.4       |                            |       | $              | 50.9       |           |       |   | $ | 6.9 |   |   |   | $ | 1.6 |   |   |

 

As of December 31, 2005, we had an employmentagreement with our former Chief Executive Officer and change in controlagreements with an additional 15 executives and key employees whichcontingently obligate us to make payments of $4.1 million if the CEO isterminated or if key employees are terminated related to a change in control ofGTSI.

At December 31, 2005GTSI was obligated under an operating lease to provide our landlord with aletter of credit in the amount of $0.2 million as a security deposit for alltenant improvements associated with the lease. We were also obligated toprovide a letter of credit in the amount of $1.75 million to guarantee our performanceof all obligations under a customer contract. This letter of credit expired onFebruary 28, 2006.

**Off-Balance SheetArrangements**

We have no off-balancesheet arrangements (as defined in Regulations S-K, Item 303, paragraph(a)(4)(ii)) that have or are reasonably likely to have a material current orfuture effect on its financial condition, changes in financial condition, salesor expenses, results of operations, liquidity, capital expenditures or capitalresources.

**New AccountingPronouncements**

In December 2004, the Financial AccountingStandards Board issued Statement of Financial Accounting Standards (“SFAS”)No. 123 (Revised 2004) “Share-Based Payment” (“FAS 123R”), which requiresthe measurement and recognition of compensation expense for all stock basedcompensation payments and supersedes our current accounting under APB 25. InApril 2005, the SEC adopted a new rule that amends the compliancedate for FAS 123R to be effective as of the beginning of the first annualreporting period that begins after June 15, 2005. Thus, we adopted thestandard as of January 1, 2006 using the modified prospective transitionmethod. We considered the implementation guidance for FAS 123R issued by theSEC in Staff Accounting Bulletin No. 107 in the adoption of FAS 123R.

Accordingly, the adoption of FAS 123R’s fair valuemethod will have a significant impact on our results of operations. The impactto net income for the year ended December 31, 2005 cannot be predicted atthis time because it will depend on levels of share-based payments granted inthe future. However, based on the unvested stock options that were outstandingas of December 31, 2005 we expect to record stock compensation ofapproximately $900 thousand during 2006 as a result of adopting FAS123R.FAS123R also requires the benefits of tax deductions in excess of recognizedcompensation cost to be reported as a financing cash flow, rather than as anoperating cash flow as required under current literature. This requirement willreduce net operating cash flows and increase net financing cash flows inperiods after adoption.

In June 2005, theFASB issued SFAS No. 154, “Accounting Changes and Error Corrections,”(“FAS 154”) which is a replacement of APB Opinion No. 20, “AccountingChanges” and SFAS No. 3, “Reporting Accounting Changes in InterimFinancial Statements”. FAS 154 changes the accounting for and reporting ofchanges in accounting principles and error corrections by requiringretrospective application to prior period financial statements unless impracticable.This statement is effective in fiscal years beginning after 

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December 15,2005. We do not expect the adoption of FAS 154 to have a significant impact onour consolidated financial statements.

**ITEM 7A.**        QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

GTSI had a $135 million Credit Facility indexed atLIBOR plus 1.75 percentage points as of December 31, 2005. This CreditFacility exposes us to market risk from changes in interest rates. For purposesof specific risk analysis, we use sensitivity analysis to determine the effectsthat market risk exposures may have.

Our results of operations are affected by changes ininterest rates due to the impact those changes have on borrowings under ourCredit Facility. If interest rates increase, our debt service obligations onthe variable rate indebtedness would increase even though the amount borrowedremained the same, which would require more cash to service our indebtedness.As of December 31, 2005, the effect of a 5% increase in interest rateswould have resulted in additional interest expense during 2005 of $0.7 millionbased on our average monthly balances. We have not used derivative instrumentsto alter the interest rate characteristics of our borrowings. AtDecember 31, 2005 we had $55.8 million of variable rate debt subject tointerest.

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**ITEM 8.**

**Report of Ernst &Young LLP,Independent Registered Public Accounting Firm**

To the Board of Directors and Stockholders of GTSICorp.

We have audited the accompanying consolidated balancesheets of GTSI Corp. as of December 31, 2005 and 2004, and the relatedconsolidated statements of operations, changes in stockholders’ equity, andcash flows for each of the three years in the period ended December 31,2005. Our audit also included the financial statement schedule listed in theIndex at Item 15(a). These financial statements and schedule are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements and the financial statement schedulebased on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred toabove present fairly, in all material respects, the consolidated financialposition of GTSI Corp. at December 31, 2005 and 2004, and the consolidatedresults of its operations and its cash flows for each of the three years in theperiod ended December 31, 2005, in conformity with U.S. generally acceptedaccounting principles. Also, in our opinion, the related financial statementschedule, when considered in relation to the basic financial statements takenas a whole, presents fairly in all material respects the information set forththerein.

The accompanying financial statements have been preparedassuming that GTSI Corp. will continue as a going concern. As more fullydescribed in Note 2, the Company incurred a net loss of $16.0 million and used$42.0 million of cash in operating activities during the year ended December 31,2005 and has not complied with certain covenants of bank loan agreements as of January 31,2006. In addition, the Company’s current lending agreement expires on May 31,2006. These conditions raise substantial doubt about the Company’s ability tocontinue as a going concern. Management’s plans in regard to these matters arealso described in Note 2. The financial statements do not include anyadjustments to reflect the possible future effects on the recoverability andclassification of assets or the amounts and classification of liabilities thatmay result from the outcome of this uncertainty.

Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the effectiveness of GTSI Corp.’sinternal control over financial reporting as of December 31, 2005, basedon criteria established in Internal Control—Integrated Framework issued by theCommittee of Sponsoring Organizations of the Treadway Commission and our reportdated April 10, 2006 expressed an unqualified opinion on management’sassessment and an adverse opinion on the effectiveness of the Company’sinternal control over financial reporting because of the existence of certainmaterial weaknesses.
|  | /s/ ERNST &  YOUNG LLP |
|--|---------------------------------|

 

McLean, VirginiaApril 10, 2006

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**FINANCIAL STATEMENT AND SUPPLEMENTARY DATAGTSI CORP.CONSOLIDATED BALANCE SHEETS**

| ** **                                                                                                                                                                                                       | ** ** | **December 31,**                                 | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                                                                                                                                                                                       | ** ** | **2005**                                              | ** ** | **2004** | ** ** |
| ** **                                                                                                                                                                                                       | ** ** | **(In thousands, except   share and per share data)** | ** ** |
| **ASSETS**                                                                                                                                                                                                       | ** ** | ** **                                            | ** ** | ** ** | ** ** |
| Current assets:                                                                                                                                                                                                  | ** ** | ** **                                            | ** ** | ** ** | ** ** |
| Cash                                                                                                                                                                                                             |       | $                                                     | 22         |   | $ | 397 |   |
| Accounts receivable, net                                                                                                                                                                                         |       | 207,886                                               |       | 204,842 |   |
| Inventory                                                                                                                                                                                                        |       | 56,666                                                |       | 59,184 |   |
| Deferred costs                                                                                                                                                                                                   |       | 14,909                                                |       | 4,218 |   |
| Other current assets                                                                                                                                                                                             |       | 9,118                                                 |       | 11,162 |   |
| Total current assets                                                                                                                                                                                             |       | 288,601                                               |       | 279,803 |   |
| Depreciable assets, net                                                                                                                                                                                          |       | 13,640                                                |       | 15,183 |   |
| Other assets                                                                                                                                                                                                     |       | 4,416                                                 |       | 1,400 |   |
| Total assets                                                                                                                                                                                                     |       | $                                                     | 306,657    |   | $ | 296,386 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                   |       |                                                  |       |   |   |
| Current liabilities:                                                                                                                                                                                             |       |                                                  |       |   |   |
| Borrowings under credit facility                                                                                                                                                                                 |       | $                                                     | 48,014     |   | $ | 1,179 |   |
| Accounts payable                                                                                                                                                                                                 |       | 159,038                                               |       | 173,218 |   |
| Accrued liabilities                                                                                                                                                                                              |       | 16,634                                                |       | 14,734 |   |
| Deferred revenue                                                                                                                                                                                                 |       | 3,611                                                 |       | 9,216 |   |
| Accrued warranty liabilities                                                                                                                                                                                     |       | 744                                                   |       | 2,429 |   |
| Total current liabilities                                                                                                                                                                                        |       | 228,041                                               |       | 200,776 |   |
| Other liabilities                                                                                                                                                                                                |       | 3,922                                                 |       | 3,473 |   |
| Total liabilities                                                                                                                                                                                                |       | 231,963                                               |       | 204,249 |   |
| Commitments and  contingencies—See Note 13                                                                                                                                                                  |       |                                                  |       |   |   |
| Stockholders’  equity                                                                                                                                                                                       |       |                                                  |       |   |   |
| Preferred stock - $0.25 par value, 680,850 shares  authorized; none issued or outstanding                                                                                                                        |       | —                                                |       | — |   |
| Common stock - $0.005 par value, 20,000,000 shares  authorized; 9,806,084 issued and 9,442,887 outstanding at December 31,  2005; and 9,806,084 issued and 8,987,643 outstanding at December 31,  2004 |       | 49                                                    |       | 49 |   |
| Capital in excess of par value                                                                                                                                                                                   |       | 42,943                                                |       | 46,817 |   |
| Retained earnings                                                                                                                                                                                                |       | 34,396                                                |       | 50,395 |   |
| Treasury stock, 361,530 shares at December 31,  2005and 818,441 shares at December 31, 2004, at cost                                                                                                   |       | (2,694                                                | )          | (5,124 | ) |
| Total stockholders’ equity                                                                                                                                                                                  |       | 74,694                                                |       | 92,137 |   |
| Total liabilities  and stockholders’ equity                                                                                                                                                                 |       | $                                                     | 306,657    |   | $ | 296,386 |   |

 

The accompanying notes are an integral part of these consolidated financial statements.

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**GTSI CORP.CONSOLIDATED STATEMENTS OF OPERATIONS**

| ** **                                          | ** ** | **For the Years Ended December 31,**                          | ** ** |
|-----------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
| ** **                                          | ** ** | **2005**                                                                               | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                          | ** ** | **(In thousands, except share and per share data)** | ** ** |
| SALES                                               |       | $                                                                                      | 886,263    |   | $ | 1,076,148 |   | $ | 954,118 |   |
| COST OF SALES                                       |       | 791,346                                                                                |       | 954,143 |   | 857,334 |   |
| GROSS MARGIN                                        |       | 94,917                                                                                 |       | 122,005 |   | 96,784 |   |
| SELLING, GENERAL & ADMINISTRATIVE EXPENSES |       | 119,451                                                                                |       | 110,855 |   | 88,347 |   |
| IMPAIRMENT CHARGE                                   |       | 981                                                                                    |       | — |   | 5,972 |   |
| TOTAL OPERATING EXPENSES                            |       | 120,432                                                                                |       | 110,855 |   | 94,319 |   |
| (LOSS) INCOME FROM OPERATIONS                       |       | (25,515                                                                                | )          | 11,150 |   | 2,465 |   |
| INTEREST AND  OTHER INCOME                          |       |                                                                                   |       |   |   |   |   |
| Lease-related income                                |       | 5,934                                                                                  |       | 3,745 |   | 526 |   |
| Interest and other income                           |       | 1,779                                                                                  |       | 2,135 |   | 2,593 |   |
| Interest expense                                    |       | (984                                                                                   | )          | (311 | ) | (287 | ) |
| Interest and other income, net                      |       | 6,729                                                                                  |       | 5,569 |   | 2,832 |   |
| (LOSS) INCOME BEFORE INCOME TAXES                   |       | (18,786                                                                                | )          | 16,719 |   | 5,297 |   |
| INCOME TAX BENEFIT (PROVISION)                      |       | 2,787                                                                                  |       | (6,455 | ) | (2,118 | ) |
| NET (LOSS) INCOME                                   |       | $                                                                                      | (15,999    | ) | $ | 10,264 |   | $ | 3,179 |   |
| (LOSS) EARNINGS  PER SHARE                          |       |                                                                                   |       |   |   |   |   |
| Basic                                               |       | $                                                                                      | (1.74      | ) | $ | 1.18 |   | $ | 0.38 |   |
| Diluted                                             |       | $                                                                                      | (1.74      | ) | $ | 1.09 |   | $ | 0.35 |   |
| WEIGHTED AVERAGE  COMMON SHARES OUTSTANDING         |       |                                                                                   |       |   |   |   |   |
| Basic                                               |       | 9,177                                                                                  |       | 8,664 |   | 8,349 |   |
| Diluted                                             |       | 9,177                                                                                  |       | 9,388 |   | 9,116 |   |

 

The accompanying notes are an integral part of these consolidated financial statements.

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**GTSI CORP.CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITYFor the Years Ended December 31, 2005, 2004 and 2003**

| ** **                                                        | ** ** | **Common Stock**   | ** ** | **Capital in** | ** ** | ** **                         | ** ** | ** **             | ** ** | **Total**           | ** ** |
|-------------------------------------------------------------------|------------|-------------------------|------------|---------------------|------------|------------------------------------|------------|------------------------|------------|---------------------|------------|
| ** **                                                        | ** ** | **Shares  Outstanding** | ** ** | **Amount**          | ** ** | **Excess of  Par Value** | ** ** | **Retained  Earnings** | ** ** | **Treasury  Stock** | ** ** | **Stockholders’  Equity** | ** ** |
| ** **                                                        | ** ** | **(In thousands)** | ** ** |
| **Balance,  December 31, 2002**                              |       |                    | 8,610      |                |       |                               | $          | 49                     |       |                |       | $ | 44,439 |   |   | $ | 36,952 |   | $ | (5,949 | ) |   | $ | 75,491 |   |   |
| Stock options  exercised                                          |       |                    | 355        |                |       |                               | —     |                   |       |                | 155        |   |   | — |   | 882 |   |   | 1,037 |   |   |
| Employee stock  purchase plan                                     |       |                    | 147        |                |       |                               | —     |                   |       |                | 203        |   |   | — |   | 891 |   |   | 1,094 |   |   |
| Common stock  purchase                                            |       |                    | (607       | )                   |       |                               | —     |                   |       |                | —     |   |   | — |   | (3,970 | ) |   | (3,970 | ) |   |
| Tax benefit of  stock options exercised                           |       |                    | —     |                |       |                               | —     |                   |       |                | 1,114      |   |   | — |   | — |   |   | 1,114 |   |   |
| Net income                                                        |       |                    | —     |                |       |                               | —     |                   |       |                | —     |   |   | 3,179 |   | — |   |   | 3,179 |   |   |
| **Balance,  December 31, 2003**                              |       |                    | 8,505      |                |       |                               | 49         |                   |       |                | 45,911     |   |   | 40,131 |   | (8,146 | ) |   | 77,945 |   |   |
| Stock options  exercised                                          |       |                    | 398        |                |       |                               | —     |                   |       |                | (713       | ) |   | — |   | 2,489 |   |   | 1,776 |   |   |
| Employee stock  purchase plan                                     |       |                    | 85         |                |       |                               | —     |                   |       |                | 262        |   |   | — |   | 533 |   |   | 795 |   |   |
| Stock based  compensation                                         |       |                    | —     |                |       |                               | —     |                   |       |                | 480        |   |   | — |   | — |   |   | 480 |   |   |
| Tax benefit of  stock options exercised                           |       |                    | —     |                |       |                               | —     |                   |       |                | 877        |   |   | — |   | — |   |   | 877 |   |   |
| Net income                                                        |       |                    | —     |                |       |                               | —     |                   |       |                | —     |   |   | 10,264 |   | — |   |   | 10,264 |   |   |
| **Balance,  December 31, 2004**                              |       |                    | 8,988      |                |       |                               | 49         |                   |       |                | 46,817     |   |   | 50,395 |   | (5,124 | ) |   | 92,137 |   |   |
| Stock options  exercised                                          |       |                    | 938        |                |       |                               | —     |                   |       |                | (3,854     | ) |   | — |   | 6,731 |   |   | 2,877 |   |   |
| Employee stock  purchase plan                                     |       |                    | 77         |                |       |                               | —     |                   |       |                | (78        | ) |   | — |   | 572 |   |   | 494 |   |   |
| Common stock  purchase                                            |       |                    | (610       | )                   |       |                               | —     |                   |       |                | —     |   |   | — |   | (4,873 | ) |   | (4,873 | ) |   |
| Stock based  compensation                                         |       |                    | —     |                |       |                               | —     |                   |       |                | 32         |   |   | — |   | — |   |   | 32 |   |   |
| Restricted stock  issued                                          |       |                    | 50         |                |       |                               | —     |                   |       |                | 153        |   |   | — |   | — |   |   | 153 |   |   |
| Reversal of stock  option related benefit recorded in prior years |       |                    | —     |                |       |                               | —     |                   |       |                | (127       | ) |   | — |   | — |   |   | (127 | ) |   |
| Net loss                                                          |       |                    | —     |                |       |                               | —     |                   |       |                | —     |   |   | (15,999 | ) | — |   |   | (15,999 | ) |   |
| **Balance, December 31, 2005**                               |       |                    | 9,443      |                |       |                               | $          | 49                     |       |                |       | $ | 42,943 |   |   | $ | 34,396 |   | $ | (2,694 | ) |   | $ | 74,694 |   |   |

 

The accompanying notes are an integral part of these consolidated financial statements.

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**GTSI CORP.CONSOLIDATED STATEMENTS OF CASH FLOWS**

| ** **                                                                                          | ** ** | **For the Years Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                                          | ** ** | **2005**                                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                          | ** ** | **(In thousands)**                                            | ** ** |
| **CASH FLOWS FROM OPERATING  ACTIVITIES:**                                                          |       |                                                          |       |   |   |   |   |
| Net (Loss) Income                                                                                   |       | $                                                             | (15,999    | ) | $ | 10,264 |   | $ | 3,179 |   |
| Adjustments to reconcile  net (loss) income to net cash (used in) provided by operating activities: |       |                                                          |       |   |   |   |   |
| Depreciation and amortization                                                                       |       | 4,250                                                         |       | 3,022 |   | 2,874 |   |
| Impairment charge                                                                                   |       | 981                                                           |       | — |   | 5,972 |   |
| Loss on disposal of property and equipment                                                          |       | —                                                        |       | — |   | 64 |   |
| Stock based compensation                                                                            |       | 185                                                           |       | 480 |   | — |   |
| Deferred tax (benefit) provision                                                                    |       | (353                                                          | )          | 4,381 |   | 502 |   |
| Tax benefit of stock options exercised                                                              |       | (127                                                          | )          | 877 |   | 1,114 |   |
| Reversal of vendor payables                                                                         |       | —                                                        |       | (10,120 | ) | — |   |
| Changes in  operating assets and liabilities:                                                       |       |                                                          |       |   |   |   |   |
| Accounts receivable                                                                                 |       | (3,044                                                        | )          | (30,372 | ) | (41,106 | ) |
| Inventory                                                                                           |       | 2,518                                                         |       | (3,197 | ) | 52 |   |
| Other assets                                                                                        |       | (11,369                                                       | )          | 8,691 |   | (3,681 | ) |
| Accounts payable                                                                                    |       | (14,180                                                       | )          | 30,903 |   | 30,003 |   |
| Other liabilities                                                                                   |       | (4,882                                                        | )          | 1,889 |   | 5,610 |   |
| Net cash (used  in) provided by operating activities                                                |       | (42,020                                                       | )          | 16,818 |   | 4,583 |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES:**                                                          |       |                                                          |       |   |   |   |   |
| Purchase of  equipment and capitalized software for internal use                                    |       | (3,688                                                        | )          | (7,535 | ) | (7,873 | ) |
| Net cash used in  investing activities                                                              |       | (3,688                                                        | )          | (7,535 | ) | (7,873 | ) |
| **CASH  FLOWS FROM FINANCING ACTIVITES:**                                                           |       |                                                          |       |   |   |   |   |
| Borrowings under  (payments on) credit facility                                                     |       | 46,835                                                        |       | (11,634 | ) | 5,274 |   |
| Common stock  purchases                                                                             |       | (4,873                                                        | )          | — |   | (3,970 | ) |
| Proceeds from  employee stock purchase plan                                                         |       | 494                                                           |       | 795 |   | 1,094 |   |
| Proceeds from  exercises of stock options                                                           |       | 2,877                                                         |       | 1,776 |   | 1,037 |   |
| Net cash provided  by (used in) financing activities                                                |       | 45,333                                                        |       | (9,063 | ) | 3,435 |   |
| NET (DECREASE) INCREASE IN CASH                                                                     |       | (375                                                          | )          | 220 |   | 145 |   |
| CASH AT BEGINNING  OF YEAR                                                                          |       | 397                                                           |       | 177 |   | 32 |   |
| CASH AT END OF  YEAR                                                                                |       | $                                                             | 22         |   | $ | 397 |   | $ | 177 |   |
| CASH PAID DURING  THE YEAR FOR:                                                                     |       |                                                          |       |   |   |   |   |
| Interest                                                                                            |       | $                                                             | 823        |   | $ | 214 |   | $ | 299 |   |
| Income taxes                                                                                        |       | $                                                             | 667        |   | $ | 2,708 |   | $ | 1,796 |   |

 

The accompanying notes are an integral part of these consolidated financial statements.

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**GTSI CORP.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFor the Years Ended December 31, 2005, 2004 and 2003**

**1.   SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES**

**A.   Nature ofOperations**

GTSI Corp. (collectively with its subsidiaries, “GTSI”or the “Company”) is an IT solutions provider, focusing predominantly on U.S.Federal, state, and local government customers. GTSI solves governmenttechnology challenges with industry-leading solutions, a powerful collection ofcontracts, dedicated teams of certified experts, flexible financing options,and ISO 9001:2000 registered global integration and distribution.

GTSI uses its technical experts to assess, design,implement and maintain complex solutions and deliver services relating tonetworking, enterprise computing, wireless, IT security, physical security,storage, and software. Additionally, GTSI markets and sells products, primarilycomputer hardware and software, through its web site, gtsi.com, providingconvenient, customized shopping zones to meet the unique and changing needs ofits customers.

For more than 20 years, the Company has combined itsunderstanding of Federal, state and local government technology needs withlong-standing relationships with global IT leaders like Panasonic, HP, Cisco,Sun Microsystems, and Microsoft.

GTSI’s primary business isconducted from its headquarters and distribution center located in Chantilly,Virginia, outside of Washington D.C., and has offices throughout the UnitedStates.

**B.   Principlesof Consolidation**

The consolidated financialstatements include the accounts of GTSI and its wholly-owned subsidiaries. Allintercompany accounts and transactions have been eliminated. Investments inwhich the Company does not control the investee but has the ability to exercisesignificant influence over its operating and financial policies are accountedfor using the equity method of accounting. During the year ended December 31,2004, the Company created two new wholly-owned subsidiaries:  GTSI Financial Services, Inc. andTechnology Logistics, Inc. (“TLI”). Certain amounts reported in previousyears have been reclassified to conform to the current presentation.

**C.   RevenueRecognition**

GTSI recognizes revenue when persuasive evidence of asale arrangement exists, delivery has occurred or services have been rendered,the sales price is fixed or determinable, and collectibility is reasonablyassured in accordance with SEC Staff Accounting Bulletin No. 104, “RevenueRecognition in Financial Statements” (“SAB 104”).

When a customer order contains multiple items such ashardware, software, and services which are delivered at varying times, theCompany determines whether the delivered items can be considered separate unitsof accounting as prescribed under Emerging Issues Task Force (“EITF”) Issue No. 00-21,“Revenue Arrangements with Multiple Deliverables” (“EITF 00-21”). EITF 00-21states that delivered items should be considered separate units of accountingif delivered items have value to the customer on a standalone basis, there isobjective and reliable evidence of the fair value of undelivered items, and ifdelivery of undelivered items is probable and substantially in GTSI’s control.

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In these circumstances, GTSI allocates revenue to eachelement based on its relative vendor specific objective evidence of fair value(“VSOE”). VSOE for products and software is established based on the Company’sGovernment Services Administration approved pricing schedules. To establishVSOE for services, the Company uses standard billing rates based on job titles.Generally, the Company is able to establish VSOE for all elements of the salesorder and bifurcate the customer order or contract accordingly. In theseinstances, sales are recognized on each element separately. However, if VSOEcannot be established or if the delivered items do not have stand alone valueto the customer without additional services provided, the Company recognizesrevenue on the contract as a whole based on either the completed-performance orproportional-performance methods as described below.

In most cases, revenue from hardware and softwareproduct sales is recognized when title passes to the customer. Based upon theCompany’s standard shipping terms, FOB destination, title passes upon deliveryof the products to the customer. However, occasionally our customers willrequest bill-and-hold transactions in situations where the customer does nothave space available to receive products or for another business purpose, inwhich case GTSI will store the purchased equipment in its distribution center.Under SAB 104, the Company only recognizes revenue for bill-and-holdtransactions when the goods are complete and ready for shipment, title and riskof loss have passed to the customer, management receives a written request fromthe customer for bill-and-hold treatment, and the ordered goods are physicallysegregated in our warehouse from other inventory and cannot be used to fulfillother customer orders.

Revenue is recognized on service contracts usingeither the completed-performance or proportional-performance method dependingon the terms of the service agreement. When the amount of services to beperformed in the last series of acts is so significant in relation to theentire service contract that performance is deemed not to have occurred untilthe final act is completed or when there are acceptance provisions based oncustomer-specified subjective criteria, the completed-performance method isused. Once the last significant act has been performed, revenue is recognized.The Company uses the proportional-performance method when a service contractspecifies a number of acts to be performed and the Company has the ability toproduce reasonable estimates. The estimates used on these contracts areperiodically updated during the term of the contract and may result in theCompany’s revision of recognized sales in the period in which they areidentified.

In many contracts, billing terms are agreed upon basedon performance milestones such as the execution of a contract, the customer’sacceptance of a list detailing the equipment and/or vendor for products, thepartial or complete delivery of products and/or the completion of specifiedservices. Payments received before delivery has occurred or services have beenrendered are recorded as deferred revenue until the revenue recognitioncriteria are met. Deferred revenue from extended warranty contracts isrecognized over the terms of the extended warranty.

The Company sells products to certain customers undersales-type lease arrangements for terms typically ranging from two to fouryears. The Company accounts for its sales-type leases according to theprovisions of Statement of Financial Accounting Standards (“SFAS”) No. 13 “Accountingfor Leases” and, accordingly, recognizes current and long-term leasereceivables, net of unearned finance income, on the accompanying balancesheets. GTSI periodically sells lease receivables to various unrelatedfinancing companies and accounts for those sales in accordance with SFAS No. 140“Accounting for the Transfers and Servicing of Financial Assets andExtinguishments of Liabilities—a Replacement of FASB Statement 125” (“FAS140”).

The Company may also enter into sales arrangementswith customers where the Company performs as an agent or broker withoutassuming the risks and rewards of ownership of the goods and services. TheCompany recognizes revenue from these transactions on a net basis in accordancewith EITF Issue No. 99-19, “Reporting Revenue Gross as a Principalversus Net as an Agent.” The Company sells third-party services, such asmaintenance contracts, and recognizes revenue on a net basis at the time ofsale.

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GTSI offers rights of return to its customers on theproducts it sells. In accordance with SFAS No. 48, “Revenue RecognitionWhen Right of Return Exists,” the Company records a sales return allowancebased on historical trends in product return rates, when such returns becamematerial. The allowance for future sales returns as of December 31, 2005was $8.6 million and was recorded as a reduction of Accounts Receivable, net.The Cost of Sales of $7.7 million related to these sales were also deferred andrecorded on the consolidated balance sheet as of December 31, 2005 asDeferred Costs.

In accordance with EITF Issue No. 02-16, “Accountingby a Customer (Including a Reseller) for Certain Consideration Received from aVendor,” the Company records cash received from a vendor as a reduction ofInventory and a subsequent reduction in Cost of Sales, unless the cash is areimbursement of a specific identifiable incremental cost or the vendorreceives, or will receive, an identifiable benefit in exchange for the cash.

In accordance with EITFIssue No. 00-10, “Accounting for Shipping and Handling Fees andCosts,” the Company records freight billed to customers as Sales and therelated shipping costs as Cost of Sales.

**D.   Cash**

Cash consists of all cashbalances. At December 31, 2005 and 2004 approximately $9.6 million and$17.7 million, respectively, was included in accounts payable which representedchecks that were issued by the Company but had not cleared its bank accounts,which would otherwise be considered a net overdraft.

**E.   Concentrationof Credit Risk**

Accounts receivable principally represents amountscollectible from the U.S. Federal Government and prime contractors to thegovernment. The Company periodically performs credit evaluations of itsnon-governmental customers and generally does not require collateral. Theallowance for non-collection of receivables is based on specific identificationof probable losses and an analysis of historical trade receivable write-offexperience. These valuation reserves are re-evaluated quarterly and adjusted asmore information about the ultimate collectibility of accounts receivablebecomes available.

As of December 31, 2005 and 2004, trade accountsreceivable from the U.S. Federal Government were $126.6 million and $143.6million, respectively. Of these balances, trade receivables from the Departmentof Defense accounted for 47.4% and 43.7% as of December 31, 2005 and 2004,respectively. No other single U.S. Federal Government department accounted for10% or more of accounts receivable. Credit losses have been insignificant.

GTSI has four majorcontracts that are up for re-compete in 2006. As a result of the Company’srecent delivery issues due to the implementation of the final phase of GEMS,management is not certain that GTSI will obtain the re-competed awards. During theyear ended December 31, 2005, these contracts represented approximately40% of Sales and 35% of Gross Margin for the Company.

**F.   CapitalizedInternal Use Software Costs**

The Company capitalizesthe cost of internal use software that has a useful life in excess of one yearin accordance with Statement of Position (“SOP”) No. 98-1, “Accountingfor the Costs of Computer Software Developed or Obtained for Internal Use” (“SOP98-1”). These costs consist of payments made to third-parties and thesalaries of employees working on such software development to customize it tothe Company’s needs. Subsequent additions, modifications or upgrades tointernal-use software are capitalized only to the extent that they allow thesoftware to perform a task it previously did not perform. Software maintenanceand training costs are expensed in the period in which they are incurred.

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**G.   Long-LivedAssets**

Long-lived assets,consisting primarily of furniture, equipment and capitalized internal usesoftware costs, are tested for recoverability whenever events or changes incircumstances indicate that their carrying amount may not be recoverable inaccordance with SFAS No. 144 “Accounting for the Impairment or Disposal ofLong-Lived Assets,” (“FAS 144”). Recoverability of long-lived assets isassessed by a comparison of the carrying amount to the estimated future netcash flows expected to result from the use of the assets and their eventualdisposition. If estimated undiscounted future net cash flows are less than thecarrying amount, the asset is considered impaired and a loss would berecognized based on the amount by which the carrying value exceeds the fairvalue of the asset.

**H.   AccountsPayable**

FAS No. 140 “Accounting for Transfers and Servicingof Financial Assets and Extinguishments of Liabilities,” states that thejudicial release from an obligation results in the extinguishment of aliability. Upon the expiration of the statute of limitations in the year ended December 31,2004, GTSI was judicially released from obligations which resulted in theCompany derecognizing $10.1 million in aged accrued payables. The impact toGTSI’s financial results was a non-cash increase to gross margin of $10.1million and an increase to net income of $6.2 million ($0.66 per share) aftertaxes were applied.

The Company purchasessignificant amounts of inventory each year and records an estimate of thepayable based on the purchase orders issued as of the balance sheet date andthe historic rate of purchase price variances, which is adjusted on a quarterlybasis. As invoices are received, the Company records adjustments for purchaseprice variances, which generally reduce Cost of Sales. During the years ended December 31,2005 and 2004, changes in management’s estimate of the amount payable for itemspurchased resulted in $2.6 million and $2.5 million increases in Gross Marginfor the years ended December 31, 2005 and 2004, respectively.

**I.   Stock based Compensation**

TheCompany uses the intrinsic value method under Accounting Principles BoardOpinion No. 25 “Accounting for Stock Issued to Employees” (“APB 25”) inaccounting for its stock option plans, which are more fully described in Note9. Generally, options are granted with an exercise price equal to the fairmarket value of the Company’s common stock on the date of the grant. Thefollowing table illustrates, in accordance with the provisions of SFAS No. 148“Accounting for Stock based Compensation—Transition and Disclosure” the effecton net (loss) income and (loss) earnings per share if compensation costs forthe Company’s stock options had been determined based on the fair value methodin accordance with SFAS No. 123 “Accounting for Stock based Compensation”for the years ended December 31, (in thousands, except per share data):

| ** **                                                                                                                                                                                          | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net (loss)  income—as reported                                                                                                                                                                 |       | $        | (15,999    | )        | $          | 10,264   |       | $ | 3,179 |   |
| Deduct: Total  stock based employee compensation expense determined under fair value based  method for all awards (net of related tax effects for the years ended  December 31, 2004 and 2003) |       | (4,492   | )          | (1,843   | )          | (1,647   | )          |
| Net (loss)  income—pro forma                                                                                                                                                                   |       | $        | (20,491    | )        | $          | 8,421    |       | $ | 1,532 |   |
| (Loss) earnings  per share—as reported                                                                                                                                                         |       |     |       |     |       |     |       |
| Basic                                                                                                                                                                                               |       | $        | (1.74      | )        | $          | 1.18     |       | $ | 0.38 |   |
| Diluted                                                                                                                                                                                             |       | $        | (1.74      | )        | $          | 1.09     |       | $ | 0.35 |   |
| (Loss) earnings per  share—pro forma                                                                                                                                                           |       |     |       |     |       |     |       |
| Basic                                                                                                                                                                                               |       | $        | (2.23      | )        | $          | 0.97     |       | $ | 0.18 |   |
| Diluted                                                                                                                                                                                             |       | $        | (2.23      | )        | $          | 0.90     |       | $ | 0.17 |   |

 

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Fordisclosure purposes, the fair value of each stock option granted is estimatedon the date of grant using the Black-Scholes option-pricing model. The fairvalue of the Company’s stock based option awards to employees was estimatedassuming no expected dividends and the following weighted-average assumptionsfor the years ended December 31:

| ** **                | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------|------------|----------|------------|----------|------------|----------|------------|
| Expected life (in  years) |       | 4.0      |       | 4.2      |       | 4.0      |       |
| Risk free  interest rate  |       | 4.04     | %          | 3.48     | %          | 3.34     | %          |
| Expected volatility       |       | 51.7     | %          | 62.7     | %          | 78.1     | %          |

 

Based on these assumptions, the average fair value ofthe options granted during the years ended December 31, 2005, 2004 and2003 was $3.59, $5.84 and $6.24, respectively. Under the Black-Scholes optionpricing model, the total value of options granted in the years ended December 31,2005, 2004 and 2003 was $1.0 million, $2.9 million and $4.3 million,respectively. These options are amortized on a pro-rata basis based on thevesting schedule specified in the option agreement.

During the year ended December 31,2004 the Company modified its definition of an employee in its stock optionplans. In accordance with Financial Accounting Standards Board (“FASB”) InterpretationNo. 44 “Accounting for Certain Transactions involving Stock Compensation,an interpretation of APB 25,” (“FIN 44”) the Company accounted for thesemodified awards as new awards to non-employees. As prescribed by FIN 44, theCompany recorded stock based compensation of approximately $32 thousand and$480 thousand ($295 thousand, net of taxes) during the years ended December 31,2005 and 2004, respectively, for stock based compensation to non-employeesbased on the fair value method. No stock compensation expense to non-employeeswas included in net income in the year ended December 31, 2003.

**J.   IncomeTaxes**

The Company accounts forincome taxes in accordance with SFAS No. 109, “Accounting for Income Taxes”(“FAS 109”), which requires the recognition of deferred tax assets andliabilities for the expected future tax effects of temporary differencesbetween the carrying amounts of assets and liabilities for financial reportingpurposes and the amounts used for income tax purposes. FAS 109 requires that avaluation allowance be established when it is more likely than not that someportion or all of a deferred tax asset will not be realized. A valuationallowance on the net deferred tax asset has been recorded as of December 31,2005.

**K.   Use ofEstimates**

The preparation offinancial statements in conformity with U.S. generally accepted accountingprinciples requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities, the disclosure of contingentassets and liabilities at year end, and the reported amounts of revenue andexpenses during the reporting period. Actual results could differ from thoseestimates. Management’s estimates and assumptions are evaluated on an ongoingbasis and are based on historical experience, current conditions and availableinformation. Significant items subject to such estimates and assumptionsinclude valuation allowances for receivables and deferred tax assets,impairments of capitalized internal use software, market value of inventory,accruals of liabilities and the fair value of stock options.

**L.   Advertising**

The costs of advertisingare expensed as incurred. Certain vendors provide GTSI with sales incentiveprograms. Generally, the funds received under these programs are determinedbased on the Company’s 

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purchasesand/or sales of the vendor’s product. The funds are earned upon performance ofspecific promotional programs or upon completion of predetermined objectivesdictated by the vendor. The Company records vendor consideration as a reductionof Inventory and a subsequent reduction in Cost of Sales when the relatedproduct is sold.

**M.   Fair Valueof Financial Instruments**

At December 31, 2005and 2004, the recorded values of financial instruments such as tradereceivables, accounts payable and credit facility borrowings approximated theirfair values based on the short-term maturities of these instruments. As of December 31,2005 and 2004, the Company believes the carrying amount of its current andlong-term lease receivables approximates their fair value since the leasereceivables are discounted at an interest rate that approximates market.

**N.   NewAccounting Pronouncements**

In December 2004, the FASB issued SFAS No. 123(Revised 2004) “Share-Based Payment” (“FAS 123R”), which requires themeasurement and recognition of compensation expense for all stock basedcompensation payments and supersedes the Company’s current accounting under APB25. In April 2005, the SEC adopted a new rule that amends thecompliance date for FAS 123R to be effective as of the beginning of the firstannual reporting period that begins after June 15, 2005. Thus, GTSI adoptedthe standard as of January 1, 2006 using the modified prospectivetransition method. GTSI considered the implementation guidance for FAS 123Rissued by the SEC in Staff Accounting Bulletin No. 107 in the adoption ofFAS 123R.

Accordingly, the adoption of FAS 123R’s fair valuemethod will have a significant impact on the Company’s results of operations. Theimpact to net income for the year ended December 31, 2006 cannot bepredicted at this time because it will depend on levels of share-based paymentsgranted in the future. However, based on the unvested stock options that wereoutstanding as of December 31, 2005, the Company expects to record grossstock compensation expense of approximately $900 thousand during the year endedDecember 31, 2006 as a result of the adoption of FAS 123R and of themodification that occurred in the year ended December 31, 2005 (see Note9). FAS123R also requires the benefits of tax deductions in excess ofrecognized compensation cost to be reported as a financing cash flow, ratherthan as an operating cash flow as required under current literature. Thisrequirement will reduce net operating cash flows and increase net financingcash flow in periods after adoption.

In June 2005, theFASB issued SFAS No. 154, “Accounting Changes and Error Corrections,” (“FAS154”) which is a replacement of APB Opinion No. 20, “Accounting Changes”and SFAS No. 3, “Reporting Accounting Changes in Interim FinancialStatements”. FAS 154 changes the accounting for and reporting of changes inaccounting principles and error corrections by requiring retrospectiveapplication to prior period financial statements unless impracticable. Thisstatement is effective in fiscal years beginning after December 15, 2005.The Company does not expect the adoption of FAS 154 to have a significantimpact on its consolidated financial statements.

**2.   GoingConcern**

The Company incurreda net loss of $16.0 million and used $42.0 million of cash in operatingactivities during the year ended December 31, 2005. In addition, theCompany has not complied with certain covenants of the Company’s $135 million revolving creditfacility with a group of banks (the “Credit Facility”). A breach of anyof the covenants or restrictions contained in the Credit Facility would resultin an event of default. Such a default could allow the lenders to discontinuelending or declare all borrowings outstanding to be due and payable. If any ofthese events occur, there is no assurance that GTSI will have sufficient fundsavailable to pay in full the total amount of obligations that become due as aresult of any 

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such acceleration, or thatGTSI will be able to find additional or alternative financing to refinance anysuch accelerated obligations. GTSI’s lenders have notified the Company that theCredit Facility will terminate on the annual renewal date of May 31, 2006.As a result, GTSI will need a replacement credit facility to meet its capitalneeds for the remainder of 2006 and beyond (see Note 15).

As of December 31,2005, GTSI’s cash was approximately $22 thousand. The Company’s net workingcapital balance as of December 31, 2005 was approximately $60 million. Inthe absence of a revolving credit facility, management does not believe thatGTSI’s existing capital resources will enable the Company to fund operations onan ongoing basis. Management plans to obtain alternative financing under arevolving credit facility with new lenders prior to the expiration of ourCredit Facility. We did not include any adjustments to the consolidatedfinancial statements to reflect the possible future effects on therecoverability and classification of assets or the amounts and classificationof liabilities that may result from the outcome of this uncertainty. Thefollowing efforts are in process to secure suitable financing, improve workingcapital and increase cash flows which all will improve the long-term viabilityof the Company:

·       OnApril 10, 2006 we signed a commitment letter to negotiate a new revolvingcredit facility with two major money center banks by May 31, 2006, theexpiration date of the current Credit Facility;

·       TheCompany is working to strengthen the core operating processes of the supplychain and improve productivity;

·       GTSIhas undertaken significant reductions in workforce in October 2005 and February 2006to reduce our costs, eliminating over 100 full time positions; and

·       Concertedefforts are underway to improve working capital by collecting aged receivables,increasing the amount of partial billings, and invoicing customers as soon asallowed.

During the fourth quarter of 2005, the Companydeveloped a strategic plan to identify and exit failing or non-strategicactivities, improve execution of the current business, and emerge as a high-valuesolutions provider. The Company plans on focusing its many efforts, doing moreprofitable and strategic activities, and doing fewer activities which areeither not profitable or non-strategic. Management has reviewed its variousactivities and eliminated or scaled back poor performing sales teams and is inthe process of focusing its marketing and sales efforts on the products,services and vendors which are most profitable. Management has reviewed theCompany’s operations to eliminate duplicative activities and create lines ofaccountability. The Company is measuring the performance of various customerteams and lines of business, and adjusting its resources to ensure deploymentto maximum advantage.

The implementation of the GEMS system in 2005 putsignificant strain on the Company and exposed several process inefficienciesthroughout GTSI. Management believes it can reduce operating costs, improvecustomer service and improve cash flow through a concerted effort to improvethe supply chain and delivery processes. Management recently aligned GTSI toput all supply-chain and IT activities in one organization to drive the variousinitiatives to realize the benefits of improved execution.

While larger sales transactions represent a smallpercentage of GTSI’s total transactions, they represent the majority of theCompany’s Gross Margin. Going forward, GTSI will continue to focus on theselarger, more profitable transactions, and drive processes and changes to makethe delivery of the smaller transactions more profitable.

In addition, GTSI willcontinue to take other actions to create and maintain a profitable company.Specifically, the Company expects to focus on the growing government IT market,execute new government contracts and utilize flexible contract vehicles,provide a high-quality centralized source for procuring it products andservices, and establish and maintain strong vendor relationships.

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**3.   Restatementsof 2005 Quarterly Financial Statements (unaudited)**

The Company hasrestated its consolidated balance sheets and statements of operations for thequarters ended March 31, 2005, June 30, 2005 and September 30,2005 for the items discussed below. The prior period adjustments have beengrouped into the following categories (which are described in more detail belowthe tables):

a)               Timing of revenuerecognition and associated cost of sales related to the delivery of productsdirectly from the Company’s suppliers to its customers;

b)              Revenue recognition;

c)               Sales returnallowance; and

d)              Inventoryvaluation.

**ConsolidatedBalance SheetMarch 31, 2005**(inthousands)

| ** **                                       | ** ** | **As Previously  Reported** | ** ** | **Adjustment** | ** ** | **Reference** | ** ** | **As Restated** | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|----------------|------------|---------------|------------|----------------------|------------|
| Accounts  receivable, net                        |       |                             | $          | 126,942        |       |          |       | $                    | 3,676      |   |   |   | a |   |   |   | $ | 130,618 |   |   |
| Total current  assets                            |       |                             | $          | 211,929        |       |          |       | $                    | 3,676      |   |   |   | a |   |   |   | $ | 215,605 |   |   |
| Total assets                                     |       |                             | $          | 228,612        |       |          |       | $                    | 3,676      |   |   |   | a |   |   |   | $ | 232,288 |   |   |
| Accounts payable                                 |       |                             | $          | 117,019        |       |          |       | $                    | 3,392      |   |   |   | a |   |   |   | $ | 120,411 |   |   |
| Total current  liabilities                       |       |                             | $          | 138,468        |       |          |       | $                    | 3,392      |   |   |   | a |   |   |   | $ | 141,860 |   |   |
| Total liabilities                                |       |                             | $          | 141,842        |       |          |       | $                    | 3,392      |   |   |   | a |   |   |   | $ | 145,234 |   |   |
| Retained earnings                                |       |                             | $          | 44,584         |       |          |       | $                    | 284        |   |   |   | a |   |   |   | $ | 44,868 |   |   |
| Total  stockholders’ equity                 |       |                             | $          | 86,770         |       |          |       | $                    | 284        |   |   |   | a |   |   |   | $ | 87,054 |   |   |
| Total liabilities and  stockholders’ equity |       |                             | $          | 228,612        |       |          |       | $                    | 3,676      |   |   |   | a |   |   |   | $ | 232,288 |   |   |

 

**Statement of OperationsFor the Three Months Ended March 31, 2005**(inthousands, except per share data)

| Sales                       |   |   | $ | 157,001 |   |   |   | $ | 3,676 |   |   |   | a |   |   |   | $ | 160,677 |   |   |
|-----------------------------|--------|--------|---|---------|--------|--------|--------|---|-------|--------|--------|--------|---|--------|--------|--------|---|---------|--------|--------|
| Cost of sales               |   |   | $ | 138,922 |   |   |   | $ | 3,282 |   |   |   | a |   |   |   | $ | 142,204 |   |   |
| Gross margin                |   |   | $ | 18,079  |   |   |   | $ | 394   |   |   |   | a |   |   |   | $ | 18,473  |   |   |
| Loss from  operations       |   |   | $ | (10,212 | )      |   |   | $ | 394   |   |   |   | a |   |   |   | $ | (9,818  | )      |   |
| Loss before  income taxes   |   |   | $ | (9,483  | )      |   |   | $ | 394   |   |   |   | a |   |   |   | $ | (9,089  | )      |   |
| Income tax  benefit         |   |   | $ | 3,673   |   |   |   | $ | (110  | )      |   |   | a |   |   |   | $ | 3,563   |   |   |
| Net loss                    |   |   | $ | (5,810  | )      |   |   | $ | 284   |   |   |   | a |   |   |   | $ | (5,526  | )      |   |
| Loss per share—basic   |   |   | $ | (0.65   | )      |   |   | $ | 0.04  |   |   |   | a |   |   |   | $ | (0.61   | )      |   |
| Loss per share—diluted |   |   | $ | (0.65   | )      |   |   | $ | 0.04  |   |   |   | a |   |   |   | $ | (0.61   | )      |   |

** **

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**ConsolidatedBalance SheetJune 30, 2005**(inthousands)

| ** **                                       | ** ** | **As Previously  Reported** | ** ** | **Adjustment** | ** ** | **Reference** | ** ** | **As Restated** | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|----------------|------------|---------------|------------|----------------------|------------|
| Accounts  receivable, net                        |       |                             | $          | 161,782        |       |          |       | $                    | 19,661     |   |   |   | a,b |   |   |   | $ | 181,443 |   |   |
| Inventory                                        |       |                             | $          | 70,072         |       |          |       | $                    | (13,753    | ) |   |   | a,b,d |   |   |   | $ | 56,319 |   |   |
| Other current  assets                            |       |                             | $          | 20,154         |       |          |       | $                    | 645        |   |   |   | a,b,d |   |   |   | $ | 20,799 |   |   |
| Total current  assets                            |       |                             | $          | 255,052        |       |          |       | $                    | 6,552      |   |   |   | a,b,d |   |   |   | $ | 261,604 |   |   |
| Total assets                                     |       |                             | $          | 272,305        |       |          |       | $                    | 6,552      |   |   |   | a,b,d |   |   |   | $ | 278,857 |   |   |
| Accounts payable                                 |       |                             | $          | 165,645        |       |          |       | $                    | 6,311      |   |   |   | a |   |   |   | $ | 171,956 |   |   |
| Deferred revenue                                 |       |                             | $          | 7,250          |       |          |       | $                    | 177        |   |   |   | b |   |   |   | $ | 7,427 |   |   |
| Total current  liabilities                       |       |                             | $          | 188,571        |       |          |       | $                    | 6,488      |   |   |   | a,b |   |   |   | $ | 195,059 |   |   |
| Total liabilities                                |       |                             | $          | 191,840        |       |          |       | $                    | 6,488      |   |   |   | a,b |   |   |   | $ | 198,328 |   |   |
| Retained earnings                                |       |                             | $          | 37,073         |       |          |       | $                    | 64         |   |   |   | a,b,d |   |   |   | $ | 37,137 |   |   |
| Total  stockholders’ equity                 |       |                             | $          | 80,465         |       |          |       | $                    | 64         |   |   |   | a,b,d |   |   |   | $ | 80,529 |   |   |
| Total liabilities  and stockholders’ equity |       |                             | $          | 272,305        |       |          |       | $                    | 6,552      |   |   |   | a,b,d |   |   |   | $ | 278,857 |   |   |

 

**Statementof OperationsFor the Three Months Ended June 30, 2005**(inthousands, except per share data)

| Sales                       |   |   | $ | 160,683 |   |   |   | $ | 15,807 |   |   |   | a,b   |   |   |   | $ | 176,490 |   |   |
|-----------------------------|--------|--------|---|---------|--------|--------|--------|---|--------|--------|--------|--------|-------|--------|--------|--------|---|---------|--------|--------|
| Cost of sales               |   |   | $ | 144,077 |   |   |   | $ | 16,509 |   |   |   | a,b,d |   |   |   | $ | 160,586 |   |   |
| Gross margin                |   |   | $ | 16,606  |   |   |   | $ | (702   | )      |   |   | a,b,d |   |   |   | $ | 15,904  |   |   |
| Loss from  operations       |   |   | $ | (11,792 | )      |   |   | $ | (702   | )      |   |   | a,b,d |   |   |   | $ | (12,494 | )      |   |
| Loss before  income taxes   |   |   | $ | (11,438 | )      |   |   | $ | (702   | )      |   |   | a,b,d |   |   |   | $ | (12,140 | )      |   |
| Income tax  benefit         |   |   | $ | 3,927   |   |   |   | $ | 481    |   |   |   | a,b,d |   |   |   | $ | 4,408   |   |   |
| Net loss                    |   |   | $ | (7,511  | )      |   |   | $ | (221   | )      |   |   | a,b,d |   |   |   | $ | (7,732  | )      |   |
| Loss per share—basic   |   |   | $ | (0.81   | )      |   |   | $ | 0.03   |   |   |   | a,b,d |   |   |   | $ | (0.84   | )      |   |
| Loss per share—diluted |   |   | $ | (0.81   | )      |   |   | $ | 0.03   |   |   |   | a,b,d |   |   |   | $ | (0.84   | )      |   |

 

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**ConsolidatedBalance SheetSeptember 30, 2005**(inthousands, except per share data)

| ** **                                       | ** ** | **As Previously  Reported** | ** ** | **Adjustment** | ** ** | **Reference** | ** ** | **As Restated** | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|----------------|------------|---------------|------------|----------------------|------------|
| Accounts  receivable, net                        |       |                             | $          | 213,519        |       |          |       | $                    | 2,809      |   |   |   | a,b,c |   |   |   | $ | 216,328 |   |   |
| Inventory                                        |       |                             | $          | 80,307         |       |          |       | $                    | (15,993    | ) |   |   | a,b,d |   |   |   | $ | 64,314 |   |   |
| Other current  assets                            |       |                             | $          | 17,994         |       |          |       | $                    | 12,116     |   |   |   | a,b,c,d |   |   |   | $ | 30,110 |   |   |
| Total current  assets                            |       |                             | $          | 324,451        |       |          |       | $                    | (1,067     | ) |   |   | a,b,c,d |   |   |   | $ | 323,384 |   |   |
| Total assets                                     |       |                             | $          | 345,053        |       |          |       | $                    | (1,067     | ) |   |   | a,b,c,d |   |   |   | $ | 343,986 |   |   |
| Accounts payable                                 |       |                             | $          | 227,310        |       |          |       | $                    | (511       | ) |   |   | a |   |   |   | $ | 226,799 |   |   |
| Deferred revenue                                 |       |                             | $          | 15,526         |       |          |       | $                    | 1,173      |   |   |   | b |   |   |   | $ | 16,699 |   |   |
| Total current  liabilities                       |       |                             | $          | 258,180        |       |          |       | $                    | 662        |   |   |   | a,b |   |   |   | $ | 258,842 |   |   |
| Total liabilities                                |       |                             | $          | 261,343        |       |          |       | $                    | 662        |   |   |   | a,b |   |   |   | $ | 262,005 |   |   |
| Retained earnings                                |       |                             | $          | 41,743         |       |          |       | $                    | (1,729     | ) |   |   | a,b,c,d |   |   |   | $ | 40,014 |   |   |
| Total  stockholders’ equity                 |       |                             | $          | 83,710         |       |          |       | $                    | (1,729     | ) |   |   | a,b,c,d |   |   |   | $ | 81,981 |   |   |
| Total liabilities  and stockholders’ equity |       |                             | $          | 345,053        |       |          |       | $                    | (1,067     | ) |   |   | a,b,c,d |   |   |   | $ | 343,986 |   |   |

 

**Statementof OperationsFor the Three Months Ended September 30, 2005**

| Sales                            |   |   | $ | 287,708 |   |   |   | $     | (17,847 | )      |   |    | a,b,c   |   |   |   | $      | 269,861 |   |   |
|----------------------------------|--------|--------|---|---------|--------|--------|--------|-------|---------|--------|--------|---------|---------|--------|--------|--------|--------|---------|--------|--------|
| Cost of sales                    |   |   | $ | 252,594 |   |   |   | $     | (14,800 | )      |   |    | a,b,c,d |   |   |   | $      | 237,794 |   |   |
| Gross margin                     |   |   | $ | 35,114  |   |   |   | $     | (3,047  | )      |   |    | a,b,c,d |   |   |   | $      | 32,067  |   |   |
| Income (loss)  from operations   |   |   | $ | 3,217   |   |   |   | $     | (3,047  | )      |   |    | a,b,c,d |   |   |   | $      | 170     |   |   |
| Loss before  income taxes        |   |   | $ | 7,506   |   |   |   | $     | (3,047  | )      |   |    | a,b,c,d |   |   |   | $      | 4,459   |   |   |
| Income tax  provision            |   |   | $ | (2,837  | )      |   |   | 1,255 |    |   |   | a,b,c,d |    |   |   | $      | (1,582 | )       |   |
| Net income                       |   |   | $ | 4,669   |   |   |   | $     | (1,792  | )      |   |    | a,b,c,d |   |   |   | $      | 2,877   |   |   |
| Earnings per share—basic    |   |   | $ | 0.50    |   |   |   | $     | (0.19   | )      |   |    | a,b,d   |   |   |   | $      | 0.31    |   |   |
| Earnings per  share—diluted |   |   | $ | 0.49    |   |   |   | $     | (0.19   | )      |   |    | a,b,d   |   |   |   | $      | 0.30    |   |   |

 

a)     **Timing of revenue recognition and associated cost of sales**

The Company did not modify the customer order fulfillmentprocess to accommodate changed system capabilities when GEMS was implemented,including properly entering the correct data for orders shipped directly fromits vendors to GTSI’s customers. As a result, supporting documentation andsystem reports were inaccurate and improperly interpreted, which resulted inerrors in the timing of recording revenue and the related costs of sales whenproducts were delivered to its customer directly from GTSI’s vendors.

b)     **Revenue recognition**

Corrections for the recognition of revenue were deemednecessary for arrangements with multiple deliverables, professional servicetransactions, leasing arrangements, specific sales returns and customeracceptance clauses.

c)     **Sales returns allowance**

Accrual of sales returns allowance due to increasedcustomer returns.

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d)     **Inventory valuation**

The Company recorded a reduction in the cost basis ofinventory for obsolete and excess inventory. Due to the flaws with theimplementation of GEMS, excess inventory was ordered that could not be sold ator above cost.

There was no effect ontotal quarterly operating, investing or financing cash flows from these priorperiod adjustments for the quarters ended March 31, 2005, June 30,2005, or September 30, 2005.

**4.   AccountsReceivable**

Accountsreceivable consists of the following as of December 31 (in thousands):

| ** **                                     | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------|------------|----------|------------|----------|------------|
| Billed and  unbilled trade accounts receivable |       | $        | 199,725    |     | $          | 182,429 |   |
| Vendor and other  receivables                  |       | 18,598   |       | 23,422   |       |
| Total accounts receivable                      |       | 218,323  |       | 205,851  |       |
| Less: Allowance  for doubtful accounts         |       | (1,837   | )          | (1,009   | )          |
| Sales return  allowance                        |       | (8,600   | )          | -        |       |
| Accounts receivable, net                       |       | $        | 207,886    |     | $          | 204,842 |   |

 

Vendor and otherreceivables primarily result from items billed to suppliers under various salesincentive programs.

**5.   TransferredAssets**

In accordance with the criteria set forth in FAS 140,lease and other receivables of $74.1 million and $39.4 million as of December 31,2005 and 2004 were accounted for as sales and, as a result, the relatedreceivables have been excluded from the accompanying consolidated balancesheets. The Company received cash of $75.1 million and $42.6 million during theyears ended December 31, 2005 and 2004 respectively, related to thesesales.

Interest and other incomeincludes $5.9 million, $3.7 million and $0.5 million in the years ended December 31,2005, 2004 and 2003, respectively, of interest income from the sale of leaseand other receivables.

**6.   Inventory**

Inventory is valued at thelower of cost or market. Cost is determined using the weighted average method.The Company writes down its inventory for obsolete or excess inventory based onassumptions about future demand and market conditions. The difficulties arisingfrom the implementation of GEMS distracted personnel from the management ofprocurement and inventory. That problem was compounded by GEMS issues whichresulted in ordering excess inventory. As a result, during the year ended December 31,2005 the Company recorded an impairment charge of $5.6 million for obsolete andexcess inventory, which is included in Cost of Sales. This expense increasedthe Company’s loss from operations by $5.6 million. During the year ended December 31,2004, GTSI recorded a charge of $0.7 million, net of insurance proceeds, inCost of Sales for inventory losses.

**7.   DepreciableAssets**

Depreciableassets are stated at cost less accumulated depreciation and amortization.Depreciation and amortization are calculated using the straight-line methodover estimated useful lives. Purchased and developed computer software forinternal use, including the GTSI Enterprise Resource Management 

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System (“GEMS”), are amortized over expected livesranging from three to seven years. Furniture and equipment useful lives rangefrom three to ten years. The useful life for leasehold improvements is thelesser of the term of the lease or the life of the improvement, which rangefrom 3 to 9 years. Costs for maintenance and repairs are charged to expensewhen incurred. Depreciable assets consist of the following at December 31(in thousands):

| ** **                                      | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|
| Office furniture  and equipment                 |       | $        | 15,312     |     | $          | 15,019 |   |
| Purchased  software for internal use            |       | 12,493   |       | 11,901   |       |
| GEMS                                            |       | 10,411   |       | 9,482    |       |
| Leasehold  improvements                         |       | 5,226    |       | 5,184    |       |
|                                            |       | 43,442   |       | 41,586   |       |
| Less accumulated  depreciation and amortization |       | (29,802  | )          | (26,403  | )          |
| Depreciable assets, net                         |       | $        | 13,640     |     | $          | 15,183 |   |

 

On April 18, 2005 GTSI replaced its legacyfulfillment system by implementing the supply chain management modules of GEMS.During the years ended December 31, 2005 and 2004, the Company capitalized$2.1 million and $5.5 million, respectively of development costs related toGEMS. In addition, during the years ended December 31, 2005 and 2004 theCompany capitalized $0.7 million and $0.1 million, respectively, for otherpurchased software for internal use.

During the year ended December 31, 2005 theCompany decided to use a web-based customer resource management (“CRM”)software instead of the CRM module of GEMS. As a result, the Company testedcertain asset groupings within GEMS for recoverability and determined animpairment loss of approximately $1.0 million, net of accumulated amortization,should be recorded in operating expenses to write down GEMS to its fair valueas required by FAS 144.

During the year ended December 31,2003 the Company changed its strategy regarding GEMS from a highly customizedenterprise resource planning (“ERP”) system to a standard ERP system tocompress the delivery time and provide significant value sooner. Due to thischange in strategy, the Company recorded an impairment charge of approximately$6.0 million for capitalized customization expenses determined to have nofuture economic value.

**8.   CreditFacility**

As of December 31, 2005 the Company had a $135million revolving Credit Facility with a group of banks that expires on May 31,2006. The Credit Facility includes a revolving line of credit (the “Revolver”)and a provision for inventory financing of vendor products (the “WholesaleFinancing Facility”). Borrowing under the Revolver is limited to 85% ofeligible accounts receivable. The Revolver is secured by substantially all ofthe Company’s assets. Borrowing under the Wholesale Financing Facility islimited to 100% of the value of GTSI’s inventory and was $29.5 million as of December 31,2005 and is included in accounts payable in the accompanying consolidatedbalance sheets. The Wholesale Financing Facility is secured by the underlyinginventory. The Credit Facility carried an interest rate indexed to the LondonInterbank Offered Rate (“LIBOR”) plus 1.75 percentage points. The CreditFacility also contains certain covenants as well as provisions specifyingcompliance with certain quarterly and annual financial ratios.

During the year ended December 31, 2005, GTSIsigned four amendments to the Credit Facility to change the size of thefacility, add additional lenders to the syndicate, change certain debtcovenants, and extend the expiration date. During the year ended December 31,2004, the Company and its lenders signed three amendments to the CreditFacility to add a new lender and add GTSI’s wholly owned subsidiaries, TLI andGTSI Financial Services, as borrowers.

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At December 31, 2005 and 2004, GTSI’s interestrate under the Credit Facility was 6.1% and 4.2%, respectively. The weightedaverage interest rates for the years ended December 31, 2005, 2004 and2003 were 5.1%, 3.2% and 3.0%, respectively.

GTSI was in compliancewith all financial covenants set forth in the Credit Facility as of December 31,2005. However, as of January 31, 2006, the Company defaulted on thefollowing financial covenants under the Credit Facility: (i) maximumfunded indebtedness to EBITDA, (ii) minimum EBIT to net sales and, (iii) minimumtangible net worth. GTSI’s lenders requested the execution of an agreement totemporarily forbear them from enforcing their rights and remedies as a resultof the events of default. Subsequent to December 31, 2005, a forbearanceagreement (the “Credit Agreement”) was executed between GTSI and its lenders.GTSI’s lenders have notified the Company that the revolving Credit Facilitywill terminate on the annual renewal date of May 31, 2006. See Note 15 foradditional details and disclosure related to the Credit Agreement. On April 3,2006, GTSI defaulted on a covenant under the Credit Agreement when the Companyreceived a staff determination letter from the NASDAQ National Market statingthat because GTSI had not filed its Annual Report on Form 10-K for2005 with the SEC, as required by Market Place Rule 4310(c)(14), GTSI’scommon stock is subject to delisting from the NASDAQ National Market. TheCompany has requested a hearing with NASDAQ which should stay the delistingpending the determination of NASDAQ’s hearing panel. While there is noassurance, management expects to avoid delisting of the Company’s common stockfrom the NASDAQ National Market by the filing of this Form 10-K. TheCompany had available credit of $41.2 million at December 31, 2005 and$59.0 million at December 31, 2004.

**9.   Stockholders’Equity**

*Purchase of CapitalStock*

The Company purchased $4.9 million and $0 of GTSI’scommon stock during the years ended December 31, 2005 and 2004,respectively. The shares purchased in 2005 were authorized under a stockpurchase plan approved by GTSI’s Board of Directors. In February 2000, theBoard of Directors approved a plan for the purchase of common stock with alimit of up to $5.25 million. In January 2002, the Board of Directorsauthorized the use of up to an additional $5.0 million for the purchase ofoutstanding shares of the Company’s common stock, provided the per share pricedid not exceed the market price. During the year ended December 31, 2005,the Board of Directors approved a $7.3 million increase to the Company’s sharerepurchase program.

During the years ended December 31,2005, 2004 and 2003, the Company purchased approximately 610 thousand, zero,and 607 thousand shares, respectively of common stock for $4.9 million, $0, and$4.0 million, respectively. As of December 31, 2005, GTSI hadauthorization for remaining future repurchases of $5.1 million;however, due to the terms of the Agreement entered into as a result ofevents of default as of January 31, 2006, the Company is currentlyrestricted from purchasing its stock. Common stock purchased for the Company’streasury is generally reissued for the employee stock purchase plan, forrestricted stock grants and upon the exercise of employee stock options.

*Stock IncentivePlans*

The Company has two stockholder approved combinationincentive and non-statutory stock incentive plans, the 1994 Stock Option Plan,as amended (“1994 Plan”) and the Amended and Restated 1996 Stock Incentive Plan(“1996 Plan”). These plans provide for the granting of options to employees(both plans) and non-employee directors (only under the 1996 Plan) to purchaseup to 3,500,000 and 300,000 shares, respectively, of the Company’s commonstock. The 1996 Plan was amended during the year ended December 31, 2005to provide for grants to Company employees and non-employee directors ofrestricted stock, restricted stock units and performance awards in cash orcommon stock. The Company has another 

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stockholder approved plan,the 1997 Non-Officer Stock Option Plan (the “1997 Plan”) which provides for thegranting of non-statutory stock options to employees (other than officers anddirectors) to purchase up to 300,000 shares of the Company’s common stock. Inaddition, GTSI has utilized a vehicle permitted under NASDAQ marketplace rules thatallows a company without stockholder approval to offer stock options toprospective employees as an inducement to join GTSI (the “CapitalizationVehicle”).

Under the 1997, 1996, and1994 Plans, options have a term of up to ten years, generally vest over fouryears and option prices are required to be at not less than 100% of the fairmarket value of the Company’s common stock at the date of grant and, except inthe case of non-employee directors, must be approved by the Board of Directorsor its Compensation Committee. Options issued under the Capitalization Vehiclehave a term of seven years, vest over four years and option prices typicallyequal the fair market value of the Company’s common stock on the date ofapproval by the Board of Directors. The vesting period for restricted stock,restricted stock units and performance awards is determined by the CompensationCommittee on an individual award basis.

*Stock Options*

Thefollowing summary presents changes in the Company’s stock options outstandingunder all plans as of December 31, 2003, 2004 and 2005:

| ** **                             | ** ** | **Number of  Option Shares** | ** ** | **Weighted Average  Exercise Price  Per Share** | ** ** |
|----------------------------------------|------------|----------------------------------------|------------|----------------------------------------------------------------|------------|
| Outstanding at  January 1, 2003   |       |                                   | 2,893,109  |                                                           |       |   | $ | 5.45 |   |   |
| Granted                                |       |                                   | 768,833    |                                                           |       |   | $ | 10.47 |   |   |
| Forfeited                              |       |                                   | (124,833   | )                                                              |       |   | $ | 7.84 |   |   |
| Expired                                |       |                                   | —     |                                                           |       |   | — |   |   |
| Exercised                              |       |                                   | (426,192   | )                                                              |       |   | $ | 5.64 |   |   |
| Outstanding at  December 31, 2003 |       |                                   | 3,110,917  |                                                           |       |   | $ | 6.57 |   |   |
| Granted                                |       |                                   | 558,500    |                                                           |       |   | $ | 11.28 |   |   |
| Forfeited                              |       |                                   | (214,125   | )                                                              |       |   | $ | 9.03 |   |   |
| Expired                                |       |                                   | (9,750     | )                                                              |       |   | $ | 9.26 |   |   |
| Exercised                              |       |                                   | (397,492   | )                                                              |       |   | $ | 4.47 |   |   |
| Outstanding at  December 31, 2004 |       |                                   | 3,048,050  |                                                           |       |   | $ | 7.53 |   |   |
| Granted                                |       |                                   | 322,500    |                                                           |       |   | $ | 8.15 |   |   |
| Forfeited                              |       |                                   | (244,125   | )                                                              |       |   | $ | 10.60 |   |   |
| Expired                                |       |                                   | (100,125   | )                                                              |       |   | $ | 10.64 |   |   |
| Exercised                              |       |                                   | (937,950   | )                                                              |       |   | $ | 4.30 |   |   |
| Outstanding at  December 31, 2005 |       |                                   | 2,088,350  |                                                           |       |   | $ | 8.57 |   |   |

 

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Thefollowing table summarizes information on stock options outstanding at December 31,2005:

| **Options Outstanding**            | ** ** | **Options Exercisable** | ** ** |
|-----------------------------------------|------------|------------------------------|------------|
| **Range of  Exercise Prices** | ** ** | **Number  Outstanding**      | ** ** | **Weighted Average  Remaining  Contractual  Life (Years)** | ** ** | **Weighted Average  Exercise Price** | ** ** | **Number  Exercisable** | ** ** | **Weighted Average  Exercise Price** | ** ** |
| $1.43-2.85                              |       |                         | 60,000     |   |   |   | 4.4 |   |   |   | $ | 2.81 |   |   | 60,000 |   |   | $ | 2.81 |   |   |
| $2.86-4.28                              |       |                         | 209,350    |   |   |   | 1.6 |   |   |   | $ | 3.84 |   |   | 209,350 |   |   | $ | 3.84 |   |   |
| $4.29-5.70                              |       |                         | 175,000    |   |   |   | 1.8 |   |   |   | $ | 5.08 |   |   | 175,000 |   |   | $ | 5.08 |   |   |
| $5.71-7.13                              |       |                         | 153,000    |   |   |   | 3.5 |   |   |   | $ | 6.41 |   |   | 135,500 |   |   | $ | 6.35 |   |   |
| $7.14-8.55                              |       |                         | 476,500    |   |   |   | 5.4 |   |   |   | $ | 8.17 |   |   | 209,750 |   |   | $ | 8.27 |   |   |
| $8.56-9.98                              |       |                         | 144,750    |   |   |   | 3.0 |   |   |   | $ | 8.86 |   |   | 142,250 |   |   | $ | 8.86 |   |   |
| $9.99-11.40                             |       |                         | 568,625    |   |   |   | 4.2 |   |   |   | $ | 11.00 |   |   | 568,625 |   |   | $ | 11.00 |   |   |
| $11.41-12.83                            |       |                         | 296,125    |   |   |   | 3.3 |   |   |   | $ | 11.99 |   |   | 290,500 |   |   | $ | 11.99 |   |   |
| $12.84-14.25                            |       |                         | 5,000      |   |   |   | 4.0 |   |   |   | $ | 13.67 |   |   | 5,000 |   |   | $ | 13.67 |   |   |
|                                    |       |                         | 2,088,350  |   |   |   | 3.7 |   |   |   | $ | 8.57 |   |   | 1,795,975 |   |   | $ | 8.64 |   |   |

 

Thefollowing table sets forth the number of options exercisable and available forgrant as of December 31, 2005:

| **Plan**               | ** ** | ** ** | ** ** | **Options  Exercisable** | ** ** | **Options Available  For Grant** | ** ** |
|------------------------|------------|------------|------------|--------------------------|------------|--------------------------------------------|------------|
| 1994 plan              |       | 52,500     |       |                     | 27,467     |                                       |       |
| 1996 plan              |       | 1,453,475  |       |                     | 636,293    |                                       |       |
| 1997 plan              |       | 29,250     |       |                     | 11,492     |                                       |       |
| Capitalization Vehicle |       | 260,750    |       |                     | unlimited  |                                       |       |

 

Thefollowing table illustrates the number of options exercisable as of December 31,

| **Plan**                | ** ** | ** ** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------|------------|------------|------------|----------|------------|----------|------------|
| 1994 plan               |       | 39,250     |       |     | 35,667     |     |       |
| 1996 plan               |       | 1,123,602  |       |     | 924,186    |     |       |
| 1997 plan               |       | 34,700     |       |     | 30,900     |     |       |
| Capitalization  Vehicle |       | 779,000    |       |     | 912,250    |     |       |
| Total                   |       | 1,976,552  |       |     | 1,903,003  |     |       |

 

During the year ended December 31, 2005, theCompany’s Board of Directors approved the acceleration of the vesting ofunvested stock options with an exercise price higher than $8.09, the marketvalue on the date of the acceleration, previously awarded to employees, officersand directors under GTSI’s stock option plans. This action affected unvestedoptions to purchase an aggregate of 515 thousand shares of common stock atexercise prices per share between $8.23 and $13.67. The vesting of theseoptions was accelerated to avoid recognizing compensation expense in futurefinancial statements upon the adoption of SFAS 123R.

In January 2003, the Company agreed that theunvested options held by one officer would automatically vest if a change incontrol of the Company occurs. The maximum compensation expense impact, if any,related to this change is $0.8 million. This change results in a newmeasurement date as required by FIN 44. No compensation expense was recorded asa result of this modification at that time or to date because the Company isunable to conclude that a change in control is likely to occur. Thecompensation expense, if recorded, would not impact the Company’s cash flows orstockholders’ equity.

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During the year ended December 31,2003, an executive submitted Company mature stock with a value of $1.1 millionpreviously purchased on the open market to pay for the exercise of 100,000stock options pursuant to the terms of the Company’s stock option plan, whichresulted in a cashless exchange of stock options for Company stock. There wereno non-cash financing transactions during the years ended December 31,2004 or 2005.

*Restricted Stock*

During the year ended December 31, 2005, theBoard of Directors approved an annual program for stock based compensation toimprove the retention of key employees. Recipients are given a choice ofreceiving stock option awards or restricted stock grants at a 3:1 conversionrate. As a result, 23,333 shares of restricted stock were issued on July 21,2005. These shares are scheduled to vest on the third, fourth, and fifthanniversaries of the grant date in equal installments.

In addition to the grants above, the Company asauthorized by its Board of Directors, issued restricted stock grants of 26,664shares of the Company’s common stock to the non-employee members of the Boardunder the Amended and Restated 1996 Stock Incentive Plan during the year ended December 31,2005. These restricted shares are scheduled to vest on June 10, 2006. Norestricted stock was issued during the years ended December 31, 2004 or2003. The weighted-average grant date fair value of restricted stock grantedduring the year ended December 31, 2005 was $8.15 per share.

The Company recorded $407thousand in stockholders’ equity for deferred compensation during the yearended December 31, 2005. No deferred compensation was recorded during theyear ended December 31, 2004. Deferred compensation is amortized on astraight-line basis over the vesting period of the grants. During the yearended December 31, 2005, $153 thousand was recorded as stock basedcompensation expense for restricted stock. No stock based compensation expensewas recorded for restricted stock during the years ended December 31, 2004or 2003.

*Employee StockPurchase Plan*

GTSI has established an Employee Stock Purchase Plan (“ESPP”).Eligible employees may elect to set aside, through payroll deduction, up to 15%of their compensation to purchase common stock of the Company. The maximumnumber of shares that an eligible employee may purchase during any offeringperiod is equal to 5% of such employee’s compensation for the 12 calendar-monthperiod prior to the commencement of an offering period divided by 85% of thefair market value of a share of common stock on the first day of the offeringperiod. The ESPP is implemented through one offering during each six-monthperiod beginning January 1 and July 1. The ESPP purchase price is 85%of the lower of the fair market value of a share of common stock on the firstday or the last day of the offering period. The Company uses its treasuryshares to fulfill the obligation of both the employee withholding and thediscount.

Thetable below summarizes the number of shares purchased by employees under theESPP during the offering periods indicated:

| **Offering period ended** | ** ** | ** ** | ** ** | **Number of  shares purchased** | ** ** | **Purchase price** | ** ** |
|-------------------------------------|------------|------------|------------|-------------------------------------------|------------|-------------------------|------------|
| December 31,  2005             |       |       | 35,612     |                                      |       |                    | $          | 6.95 |   |   |
| June 30,  2005                 |       |       | 41,605     |                                      |       |                    | $          | 5.92 |   |   |
| December 31,  2004             |       |       | 40,994     |                                      |       |                    | $          | 8.93 |   |   |
| June 30,  2004                 |       |       | 44,098     |                                      |       |                    | $          | 9.73 |   |   |
| December 31,  2003             |       |       | 81,314     |                                      |       |                    | $          | 7.44 |   |   |
| June 30, 2003                  |       |       | 65,780     |                                      |       |                    | $          | 7.44 |   |   |

 

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The weighted average fair market value of shares underthe ESPP was $6.40 in 2005, $9.35 in 2004, and $7.44 in 2003. GTSI has reserved1,650,000 shares of common stock for the ESPP, of which 793,890 were availablefor future issuance as of December 31, 2005.

The ESPP was amended on December 27,2005, so that the purchase price is 95% of the lower of the fair market valueof a share of common stock on the first day or the last day of the offeringperiod, effective January 1, 2006 going forward. No other material changeswere made to the plan.

**10.   EarningsPer Share**

Basic earnings per share are calculated by dividingnet income or loss by the weighted average shares outstanding during theperiod, which includes shares of restricted stock that are fully vested. Dilutedearnings per share are computed similarly to basic earnings per share, exceptthat the weighted average shares outstanding are increased to includeequivalents, when their effect is dilutive. Antidilutive employee stock optionstotaling 741 thousand and restricted stock units totaling 52 thousand have beenexcluded for the year ended December 31, 2005.

Thefollowing table sets forth the computation of basic and diluted (loss) earningsper share (in thousands, except per share amounts) for the years ended December 31:

| ** **                                                                            | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Basic (loss) earnings  per share:                                                     |       |     |       |     |       |     |       |
| Net (loss) income                                                                     |       | $        | (15,999    | )        | $          | 10,264   |       | $ | 3,179 |   |
| Weighted average shares outstanding                                                   |       | 9,177    |       | 8,664    |       | 8,349    |       |
| Basic (loss) earnings per share                                                       |       | $        | (1.74      | )        | $          | 1.18     |       | $ | 0.38 |   |
| Diluted (loss)  earnings per share:                                                   |       |     |       |     |       |     |       |
| Net (loss) income                                                                     |       | $        | (15,999    | )        | $          | 10,264   |       | $ | 3,179 |   |
| Weighted average shares outstanding                                                   |       | 9,177    |       | 8,664    |       | 8,349    |       |
| Incremental shares attributable to the assumed exercise  of outstanding stock options |       | N/A      |       | 724      |       | 767      |       |
| Weighted average shares and equivalents                                               |       | 9,177    |       | 9,388    |       | 9,116    |       |
| Diluted (loss)  earnings per share                                                    |       | $        | (1.74      | )        | $          | 1.09     |       | $ | 0.35 |   |

 

**11.   IncomeTaxes**

Theprovision for income taxes consists of the following (in thousands):

| ** **                            | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------------|------------|---------------------------------------------|------------|
| ** **                            | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Current:                              |       |                                        |       |   |   |   |   |
| Federal                               |       | $                                           | 2,820      |   | $ | (1,826 | ) | $ | (1,373 | ) |
| State                                 |       | 320                                         |       | (248 | ) | (243 | ) |
|                                  |       | 3,140                                       |       | (2,074 | ) | (1,616 | ) |
| Deferred:                             |       |                                        |       |   |   |   |   |
| Federal                               |       | (321                                        | )          | (3,858 | ) | (427 | ) |
| State                                 |       | (32                                         | )          | (523 | ) | (75 | ) |
|                                  |       | (353                                        | )          | (4,381 | ) | (502 | ) |
| Total income tax benefit  (provision) |       | $                                           | 2,787      |   | $ | (6,455 | ) | $ | (2,118 | ) |

 

Deferredincome taxes include the net tax effects of net operating loss (“NOL”)carryforwards and the net tax effects of temporary differences between the carryingamounts of assets and liabilities and the 

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amounts recorded for income tax purposes. Thecomponents of the deferred tax assets and liabilities are as follows at December 31(in thousands):

| ** **                           | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|
| Deferred tax assets:                 |       |     |       |     |       |
| Allowance for doubtful accounts      |       | $        | 552        |     | $          | 273 |   |
| Inventory reduction of cost basis    |       | 2,643    |       | 103      |       |
| Sales return allowance               |       | 334      |       | —   |       |
| Accrued warranty liabilities         |       | 308      |       | 1,047    |       |
| Bid and proposal costs               |       | 876      |       | 433      |       |
| Vacation accrual                     |       | 499      |       | 499      |       |
| Other reserves and accruals          |       | 319      |       | 551      |       |
| Deferred revenue                     |       | 265      |       | 221      |       |
| Other                                |       | 171      |       | 99       |       |
| Net operating losses and tax credits |       | 2,200    |       | —   |       |
| Total deferred tax assets            |       | 8,166    |       | 3,226    |       |
| Deferred tax  liabilities:           |       |     |       |     |       |
| Prepaid expenses and other           |       | (268     | )          | —   |       |
| Depreciation and amortization        |       | (2,901   | )          | (2,746   | )          |
| Total deferred tax liabilities       |       | (3,169   | )          | (2,746   | )          |
| Valuation  allowance                 |       | (4,997   | )          | —   |       |
| Net deferred tax assets              |       | $        | —     |     | $          | 480 |   |

 

The Company has provided a valuation allowance againstthe full amount of the net deferred tax assets at December 31, 2005,because in the opinion of management, it is more likely than not that thesedeferred tax assets will not be realized.

Thefollowing is a reconciliation of the statutory U.S. income tax rate to theCompany’s effective tax rate:

| ** **                                  | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                  | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Statutory rate                              |       | (34.0                                       | )%         | 34.5 | % | 34.0 | % |
| State income  taxes, net of Federal benefit |       | (2.4                                        | )          | 3.3 |   | 4.0 |   |
| Other                                       |       | 2.1                                         |       | 0.8 |   | 2.0 |   |
| Change in  valuation allowance              |       | 19.5                                        |       | — |   | — |   |
| Effective tax  rate                         |       | (14.8                                       | )%         | 38.6 | % | 40.0 | % |

 

At December 31, 2005,the Company has net operating loss carryforwards of approximately $5.7 millionfor Federal income tax purposes which will expire in 2025. Approximately $3.6million of the NOL carryforward relates to stock based compensation expense forwhich subsequently recognized tax benefits will be allocated to Capital inExcess of Par Value. The tax deduction benefit from the exercise of stockoptions of $0, $0.9 million, and $1.1 million was recorded to Capital in Excessof Par Value for the years ended December 31, 2005, 2004 and 2003,respectively.

**12.   401(k) Plan**

Effective April 1991,GTSI adopted the Employees’ 401(k) Investment Plan (the “Plan”), a savingsand investment plan intended to be qualified under Section 401 of theInternal Revenue Code of 1986, as amended (the “Code”). All employees of theCompany who are at least 21 years of age are eligible to participate. The Planis voluntary and allows participating employees to make pretax contributions,subject 

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tolimitations under the Code, of a percentage (not to exceed 30%) of their totalcompensation. Employee contributions are fully vested at all times. GTSImatches employee contributions 50% of the first five percent of eligible pay.In the years ended December 31, 2005, 2004 and 2003, the Companycontributed approximately $1.2 million, $1.0 million and $1.0 million to the Plan,respectively.

**13.   Commitmentsand Contingencies**

*Product Warranties*

GTSIoffers extended warranties on certain products which are generally covered forthree or five years beyond the warranty provided by the manufacturer. Productsunder extended warranty require repair or replacement of defective parts at nocost to the customer. The Company records warranty liabilities at the time ofsale for the estimated costs that may be incurred under its extended warrantycontracts. The following table summarizes the activity related to productwarranty liabilities for the years ended December 31 (in thousands):

| ** **                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------|------------|----------|------------|----------|------------|
| Accrued  warranties at beginning of year   |       | $        | 2,429      |     | $          | 4,555 |   |
| Charges made  against warranty liabilities |       | (1,401   | )          | (2,074   | )          |
| Adjustments to  warranty reserves          |       | (613     | )          | (1,659   | )          |
| Accruals for  additional warranties sold   |       | 209      |       | 1,607    |       |
| Accrued warranties at  end of year         |       | $        | 624        |     | $          | 2,429 |   |

 

Revenuefrom extended warranty contracts is recorded as Deferred Revenue andsubsequently recognized over the term of the contract. The following tablesummarizes the activity related to the deferred warranty revenue for the yearsended December 31 (in thousands):

| ** **                                       | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
| Deferred warranty  revenue at beginning of year  |       | $        | 2,598      |     | $          | 2,819 |   |
| Deferred warranty  revenue recognized            |       | (1,370   | )          | (1,384   | )          |
| Revenue deferred  for additional warranties sold |       | 133      |       | 1,163    |       |
| Deferred warranty  revenue at end of year        |       | $        | 1,361      |     | $          | 2,598 |   |

 

*Lease Commitments*

The Company conducts its operations from leased realproperties, which include offices and a warehouse. These obligations expire atvarious dates through 2011. Most of the leases contain renewal options atinception, some of which have been exercised, as well as escalation clauses. Noleases contain purchase options or restrictions of the Company’s activitiesconcerning dividends, additional debt, or further leasing. Rent expense for theyears ended December 31, 2005, 2004 and 2003 was approximately $2.7million, $2.4 million and $2.5 million, respectively. Future minimum leasepayments under operating leases that had initial or remaining non-cancelablelease terms in excess of one year at December 31, 2005 are as follows (inthousands):

| 2006                         |   | $     | 2,862  |   |
|------------------------------|--------|-------|--------|--------|
| 2007                         |   | 3,074 |   |
| 2008                         |   | 3,078 |   |
| 2009                         |   | 785   |   |
| 2010                         |   | 806   |   |
| Thereafter                   |   | 762   |   |
| Total minimum lease payments |   | $     | 11,367 |   |

 

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*Contingencies*

In December 2004, theCompany became aware that a potential payroll liability existed for employeesworking in GTSI’s office in Germany. Management determined that a tax liabilitywas probable and accrued approximately $0.8 million in estimated accruedliabilities. During the third quarter of 2005, the Company entered into asettlement agreement with the German tax authorities for $0.5 million and theremaining accrual of $0.3 million was reversed and recorded as a reduction ofselling, general and administrative expenses.

*Letter of Credit*

GTSI was obligated under an operating lease to provideits landlord with a letter of credit in the amount of $0.2 million at December 31,2005 and $0.8 million at December 31, 2004, as a security deposit for alltenant improvements associated with the lease.

At December 31, 2005and 2004, GTSI was obligated under a customer contract to provide a letter ofcredit in the amount of $1.75 million to guarantee the performance by theCompany of all obligations under the contract. This obligation expired on February 28,2006.

*EmploymentAgreements*

The Company has anemployment agreement with its former Chief Executive Officer which provides forpayment of an amount equal to his annual base salary plus bonus monies equal tothe previous year’s bonus payments upon termination of employment. In addition,the Company has change in control severance agreements covering 16 executivesand key employees. These arrangements provide for payments of as much as 18months of total target compensation and continuation of benefits upon theoccurrence of specified events. As of December 31, 2005, the Company didnot believe it probable that any of the specified events would occur.Accordingly, no accrual for severance was recorded as of December 31,2005. If information becomes known to the Company at a later date whichindicates severance of one or more covered executives is probable, accruals forseverance will be required (see Note 15).

*Legal Proceedings*

The Company is occasionally involved in variouslawsuits, claims, and administrative proceedings arising in the normal courseof business. The Company believes that any liability or loss associated withsuch matters, individually or in the aggregate, will not have a materialadverse effect on the Company’s financial condition or results of operations.

In November 2003,GTSI was served with a $25 million lawsuit, with treble damages, related to analleged breach of contract due to the termination of Ichiban, Inc., a formersubcontractor. This suit was filed in Virginia Circuit Court in Fairfax County,Virginia and follows the Company’s earlier lawsuit against the formersubcontractor. The case was decided in the Company’s favor resulting in anaward of $1.4 million in attorneys’ fees and costs. The plaintiff filed anappeal in October 2005 which the Supreme Court of Virginia refused on February 17,2006. The plaintiff has filed a Petition for a rehearing with the Supreme Courtof Virginia. In the opinion of management, resolution of this matter will nothave a material adverse effect upon the financial position or future operatingresults of the Company. The Company is aggressively working to collect theawarded attorneys’ fees and costs from Ichiban; however, in accordance withSFAS No. 5, “Accounting for Contingencies,” no amounts for this gaincontingency were accrued as of December 31, 2005.

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**14.   SegmentReporting**

GTSIengages in business activities as one operating segment that provides hardware,software and services primarily to the U. S. Federal Government. The Company’schief operating decision maker evaluates performance and determines resourceallocation based on GTSI’s consolidated sales and operating results. Thefollowing table summarizes the Company’s sales by type for the years ended December 31(in thousands):

| ** **                           | ** ** | **2005** | ** ** | **2004** | ** ** | **2003**  | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|-----------|------------|
| Hardware                             |       | $        | 677,678    |     | $          | 834,144   |       | $ | 692,543 |   |
| Software                             |       | 141,648  |       | 155,724  |       | 154,468   |       |
| Resold  third-party service products |       | 48,831   |       | 66,618   |       | 91,211    |       |
| Services                             |       | 18,106   |       | 19,662   |       | 15,896    |       |
| Total                                |       | $        | 886,263    |     | $          | 1,076,148 |       | $ | 954,118 |   |

 

*Major Customers*

All of GTSI’s sales areearned from U.S. companies. Sales to multiple agencies and departments of theU.S. Federal Government, either directly or through prime contractors,accounted for approximately 92%, 95% and 98% of the Company’s consolidatedsales during the years ended December 31, 2005, 2004, and 2003,respectively.

**15.   SubsequentEvents**

On February 13, 2006, the Company announced afurther business alignment related to implementing its strategic plan to moveGTSI into the solutions marketplace. In accordance with this plan, the Companyeliminated duplication within the Company and transitioned out of activitieswhich have failed to yield adequate profitability.

On February 16, 2006, the Company announced thatthe Board of Directors had named James J. Leto as the Company’s President andChief Executive Officer effective immediately. Mr. Leto has been a memberof the Board of Directors since 1996 and will retain his seat. In addition,former CEO and Chairman of the Board, M. Dendy Young, will maintain hisposition as Chairman of the Board. The Company entered into a TransitionAgreement on February 15, 2006 with Mr. Young in connection with hisresignation as CEO. This agreement terminates the terms of the EmploymentAgreement dated January 1, 2001 between the Company and M. Dendy Young andprovides for a payment of $1.1 million over an 18-month period, as wellas reimbursement for certain benefits and legal fees. As a result of the Boardof Directors’ appointment of James J. Leto, the Company entered into anemployment agreement dated February 16, 2006.

On March 10,2006, the Company and its lenders executed a forbearance agreement in respectof the Company’s Credit Facilities (the “Credit Agreement”) principally as theresult of receiving a notice of default from its lenders during February 2006related to the Company’s financial performance for the month ended January 31,2006. Under the terms of the Credit Agreement, the Lenders agreed to forbearfrom exercising their rights and remedies against GTSI in respect of certainexisting defaults under the Credit Facility and to continue to advance funds tothe Company until May 31, 2006, unless GTSI is in breach of the CreditAgreement at an earlier date. Under the Credit Agreement, in addition to itsobligations under the Credit Facility, the Company agreed to:

·       Provideincreased access to its financial records to its lenders including dailyborrowing base certificates; weekly cash flow projections and accountcollection activity for receivables greater than 90 days; semi-monthly detailedaccounts aging, inventory, and accounts payable reports; and

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·       Tohire a financial advisor to evaluate the Company’s business plan.

The Agreementincluded the following material modifications:

·       Decreasedthe size of the Credit Facility from $135 million to $75 million;

·       Duringthe period from March 10, 2006 to May 31, 2006, suspended theapplication of the Maximum Total Funded Indebtedness to EBITDA and Minimum EBITto Net Sales ratio covenants;

·       Decreasedthe minimum tangible net worth requirement from $60 million to $50 million;

·       Forthe months of February, March, April and May, 2006, added a PeriodicPre-Tax Loss requirement not to exceed $7.0 million, $3.9 million, $4.3 millionand $1.9 million, respectively; and

·       Increasedthe interest rate on borrowed funds to LIBOR plus 3.0% per annum.

As required by the Credit Agreement, the Company paida $225,000 fee to the Lenders.

On April 3, 2006, the Company defaulted on thecovenant under the Credit Agreement when it received a staff determinationletter from the NASDAQ National Market stating that because GTSI has not filedits Annual Report on Form 10-K for 2005 with the SEC, as required byMarket Place Rule 4310(c)(14), GTSI’s common stock is subject to delistingfrom the NASDAQ National Market. GTSI has requested a hearing with NASDAQ whichshould stay the delisting pending the determination of NASDAQ’s hearing panel. Whilethere is no assurance, the Company expects to avoid delisting of its commonstock from the NASDAQ National Market by the filing of this Form 10-Kfor 2005 with the SEC before delisting would otherwise take effect.

On April 10, 2006 the Company signed a commitmentletter to negotiate a new revolving credit facility with two major money centerbanks by May 31, 2006, the expiration date of the current Credit Facility.The Company and the lenders are working to complete their due diligence effortsand management expects to execute a new revolving credit facility agreementprior to June 1, 2006.

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**16. SelectedQuarterly Financial Data (unaudited)**

The following summary illustrates selected quarterlyfinancial data for the two years ended December 31, 2005. The first,second and third quarters of 2005 have been restated as described morecompletely in Note 3 of these consolidated financial statements. Therestatements result from prior period adjustments for (i) timing ofrevenue recognition and associated cost of sales between quarters related tothe delivery of products directly from the Company’s suppliers to itscustomers; (ii) corrections for the recognition of revenue forarrangements with multiple deliverables, professional service transactions,leasing arrangements, sales returns, and customer acceptance clauses; (iii) accrualof a sales return allowance; and (iv) a reduction in the cost basis ofinventory for obsolete and excess inventory.

GTSI has historicallyexperienced significant seasonal fluctuations in its operations as a result ofthe U.S. Federal Government buying and funding patterns. Results of any one ormore quarters are not necessarily indicative of annual results or continuingtrends.

| ** **                        | ** ** | **2005**                                                           | ** ** |
|-----------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                        | ** ** | **Q1  (restated)**                                                 | ** ** | **Q2  (restated)** | ** ** | **Q3  (restated)** | ** ** | **Q4** | ** ** | **Total** | ** ** |
| ** **                        | ** ** | **(in thousands, except per share data)** | ** ** |
| Sales                             |       | $                                                                  | 160,677    |   | $ | 176,490 |   | $ | 269,861 |   | $ | 279,235 |   | $ | 886,263 |   |
| Gross margina                     |       | $                                                                  | 18,473     |   | $ | 15,904 |   | $ | 32,067 |   | $ | 28,473 |   | $ | 94,917 |   |
| Net (loss) income                 |       | $                                                                  | (5,526     | ) | $ | (7,732 | ) | $ | 2,877 |   | $ | (5,618 | )c | $ | (15,999 | ) |
| Basic (loss) earnings  per share  |       | $                                                                  | (0.61      | ) | $ | (0.84 | ) | $ | 0.31 |   | $ | (0.61 | ) | $ | (1.74 | ) |
| Diluted (loss) earnings per share |       | $                                                                  | (0.61      | ) | $ | (0.84 | ) | $ | 0.30 |   | $ | (0.61 | ) | $ | (1.74 | ) |

 

| ** **                        | ** ** | **2004** | ** ** |
|-----------------------------------|------------|----------|------------|
| ** **                        | ** ** | **Q1**   | ** ** | **Q2** | ** ** | **Q3** | ** ** | **Q4** | ** ** | **Total** | ** ** |
| Sales                             |       | $        | 178,623    |   | $ | 238,990 |   | $ | 330,645 |   | $ | 327,890 |   | $ | 1,076,148 |   |
| Gross marginb                     |       | $        | 18,082     |   | $ | 21,537 |   | $ | 46,723 |   | $ | 35,663 |   | $ | 122,005 |   |
| Net (loss) income                 |       | $        | (1,381     | ) | $ | (1,553 | ) | $ | 10,454 |   | $ | 2,744 |   | $ | 10,264 |   |
| Basic (loss) earnings  per share  |       | $        | (0.16      | ) | $ | (0.18 | ) | $ | 1.21 |   | $ | 0.31 |   | $ | 1.18 |   |
| Diluted (loss) earnings per share |       | $        | (0.16      | ) | $ | (0.18 | ) | $ | 1.13 |   | $ | 0.29 |   | $ | 1.09 |   |

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a)                GrossMargin for the year ended December 31, 2005 included a $5.6 million chargefor excess and obsolete inventory to write-down Inventory to its market valueas discussed in Note 6 of the consolidated financial statements. Gross Marginwas reduced $1.6 million in Q2, $0.4 million in Q3 and $3.6 million in Q4 of2005 for this Inventory impairment. This was offset in Q4 by the positiveeffects to Gross Margin of $2.6 million due to a change in estimated payable tovendors.

b)               GrossMargin for the year ended December 31, 2004 included the positive effectsof the derecognition of aged Accounts Payable of $10.1 million in Q3. Inaddition, Gross Margin reflects the positive impact of the change in estimatedpayable to vendors of $0.7 million in Q3 and $1.8 million in Q4. The totalincrease to Gross Margin in the year ended December 31, 2004 for theseitems was $12.6 million. See Note 1 to the consolidated financial statementsfor additional details.

c)                During Q4, theCompany recorded a valuation allowance against its net deferred tax asset,which increased net loss by $3.7 million

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**ITEM 9.**                CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS

None.

**ITEM 9A.**        CONTROLSAND PROCEDURES

An evaluation was carried out under the supervisionand with the participation of our management, including the Chief ExecutiveOfficer and Chief Financial Officer, of the effectiveness of the design andoperation of our disclosure controls and procedures, as defined in Rules 13a-15(e) or15d—15(e) under the Securities Exchange Act of 1934, as amended, (the “ExchangeAct”) as of December 31, 2005. Our disclosure controls and procedures aredesigned to (i) ensure that information required to be disclosed by us inreports we file or submit under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in the Securities andExchange Commission’s rules and forms and (ii) is accumulated andcommunicated to GTSI’s management including our principal executive officer andour principal financial officer, as appropriate to allow timely decisionsregarding required disclosures. Based on this evaluation, our Chief ExecutiveOfficer and Chief Financial Officer concluded that, as a result of the materialweaknesses set forth below, our disclosure controls and procedures were noteffective as of December 31, 2005.

After management concluded that there were materialweaknesses, we performed additional analyses and other post-closing proceduresto ensure that our consolidated financial statements included in this AnnualReport on Form 10-K were prepared in accordance with generallyaccepted accounting principles and present fairly in all material respects ourfinancial position, results of operations and cash flows for the periodspresented.

There was no change in our internal control overfinancial reporting during our fourth quarter of the year ended December 31,2005 that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

**MANAGEMENT’S REPORTON INTERNAL CONTROL OVER FINANCIAL REPORTING**

Our management is responsible for establishing andmaintaining adequate internal control over financial reporting as defined inExchange Act Rules 13a—15(f) and 15d-15(f). Under Section 404of the Sarbanes-Oxley Act of 2002, our management is required to assess theeffectiveness of our internal control over financial reporting as of the end ofthe fiscal year and report, based on that assessment, whether our internalcontrol over financial reporting is effective.

Our internal control over financial reporting is aprocess designed to provide reasonable assurance regarding the reliability offinancial reporting and the preparation of financial statements for external reportingpurposes in accordance with U.S. generally accepted accounting principles (“GAAP”).Under the supervision and with the participation of our management, includingour Chief Executive Officer and Chief Financial Officer, management conducted areview, evaluation, and assessment of the effectiveness of our internal controlover financial reporting as of December 31, 2005, based upon the criteriaset forth in Internal Control—Integrated Framework established by the Committeeof Sponsoring Organizations of the Treadway Commission (“COSO”).

A material weakness, as defined under standardsestablished by the Public Company Accounting Oversight Board’s AuditingStandard No. 2, is a control deficiency, or combination of controldeficiencies, that results in more than a remote likelihood that a materialmisstatement of annual or interim financial statements would not be preventedor detected.

As part of its year-end reporting and the preparationof this Annual Report on Form 10-K for the year ended December 31,2005, management concluded it was necessary to restate GTSI’s consolidatedfinancial statements for the quarters ended March 31, 2005, June 30,2005 and September 30, 2005 (as further described in Note 3 of ourconsolidated financial statements) to record inventory properly at lower ofcost or market value; to record sales and cost of sales in accordance with GAAPin the proper reporting periods in 2005; and to record various otheradjustments in a number of areas.

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Based on management’s assessment of internal controlover financial reporting as of December 31, 2005, management concludedthat GTSI’s internal control over financial reporting was ineffective becauseof the following material weaknesses:

**Finance and Accounting Staffing.****  **Management determined that GTSI, as ofDecember 31, 2005 and for a period of time prior to that date, had aninsufficient number of finance and accounting staff and some of our finance andaccounting staff lacked sufficient training and experience in areas such asaccounting for leasing transactions, revenue recoginition for services, andincome taxes. During our review of the internal control environment, managementdetermined that certain of the controls to be performed during the 2005quarterly and year-end financial close process had not been performed properly,which was due to turnover in three key accounting management positions during2005 and also due to insufficient resources to handle the new processes andprocedures associated with GEMS, growth in our professional services businessline, and increasingly sophisticated leasing transactions.

**Financial Close and Reporting Process.**   Managementdetermined that GTSI had insufficient controls over the quarterly and year-endfinancial close and reporting process. This deficiency was exacerbated by thefinance and accounting staffing material weakness as noted above, and wasmanifested primarily in control deficiencies in the accounting for inventoryvaluation, customer returns, revenue recognition (including leasing andprofessional services transactions), accruals and the tax provision, whichrequired significant post-closing adjustments to inventory, accounts payable,accounts receivable, accrued liabilities, sales, cost of sales and incometaxes.

Given the complexity of our changing business model,we either lacked finance and accounting staff with the requisite qualificationsand training to perform the quarterly and year-end financial close andreporting process, or the closing procedures (including the subsequent reviewand approval functions) were minimally or inadequately documented or performed.The effect of these deficiencies was that adjustments were required to berecorded that had a material impact on net (loss) income for the 2005 interimperiods during the year ended December 31, 2005. See Note 3 to ouraccompanying consolidated financial statements.

Due to the pervasiveness and the magnitude of theerrors in the areas noted above, management concluded that GTSI had a materialweakness in its financial close and reporting process.

**Customer Order Fulfillment Process.**   Managementdetermined that GTSI had insufficient execution and oversight related to itscustomer order fulfillment process during 2005, which resulted in restatementsto all the interim periods in 2005 as well as material adjustments at year-end.Specifically, GTSI recorded sales, cost of goods sold, accounts receivable andaccounts payable in the incorrect reporting periods during 2005 due to a numberof factors including inadequate training, inappropriate data entry, vendorpayable reconciliations not being performed on a timely basis, and lack ofoversight and communications between the appropriate departments.

These deficiencies were caused by, in part, our April 2005implementation of the supply chain module of GEMS. Management under-estimatedthe impact the new system would have on the amount of time and resources neededto properly process customer order fulfillment transactions, and did not modifyour customer order fulfillment process to accommodate changed systemcapabilities.

Due to the pervasiveness and the magnitude of theerrors in the areas noted above, management concluded that GTSI had a materialweakness in its customer order fulfillment process.

We corrected all errors discovered during the closing ofour financial records for the year ended December 31, 2005. In addition,management concluded it was necessary to restate GTSI’s consolidated financialstatements for the quarters ended March 31, 2005, June 30, 2005 andSeptember 30, 2005 (as further described in Note 3 of ourconsolidated financial statements) to record inventory properly at lower ofcost or market value; to record sales and cost of sales in accordance with GAAPin the proper reporting periods in 2005; and to record various otheradjustments in a number of areas. Therefore, we are restating our previouslyreported results for these 2005 quarters in this Annual Report on Form 10-K.Until these deficiencies are remediated, there is more than a remote likelihoodthat a material misstatement to the 

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annual or interimconsolidated financial statements could occur and not be prevented or detectedby our controls in a timely manner.

Management’s assessment of the effectiveness ofinternal control over financial reporting as of December 31, 2005 has beenaudited by Ernst & Young LLP, an independent registered publicaccounting firm. Their report appears below.

**REMEDIATION OFMATERIAL WEAKNESSES**

Management is required to ensure that its personnelthroughout all areas of the company have the competence, resources, training,and supervision; that policies and procedures necessary for their assignedlevels of responsibility are in place; and that sufficient staff is present toeffectively perform all processes necessary to maintaining a proper internalcontrol environment. Management is also responsible for maintaining effectiveinternal control processes over its financial close and reporting process.

In order to remediate theaforementioned material weaknesses, management is taking the following actions:

i.                   Increasing thesize, expertise and training of the finance and accounting staff to includeadequate resources for ensuring GAAP compliance in revenue recognition for multiple-elementarrangements, leasing and professional service transactions, transfers offinancial assets, and the related accounting.

ii.               Upgrading thecapabilities of certain staff in existing finance and accounting positions toensure that our professionals possess sufficient GAAP knowledge and experiencenecessary not only to perform their assigned tasks, but also to understand howthose tasks are related to others within GTSI and to improve the overallquality and integrity of record keeping and financial reporting.

iii.           Enhancing theaccounting policies and procedures to provide adequate, sufficient, and usefulguidance to staff such that adherence to them should result in higher degreesof assurance of accurate and complete financial reporting.

iv.             Implementing a morerigorous account reconciliation and account aging review and approval processon a quarterly basis, particularly in the accounts receivable and accountspayable areas.

v.                 Improving thequarterly financial close process, particularly related to the review forinventory obsolescence, and revenue recognition for professional services,leasing and multiple element arrangements to better ensure all relevantaccounting issues are known and properly addressed before financial reports areissued.

vi.             Improving theinformation system program change process to ensure that current and futurechanges to the ERP system are properly managed, with the impact upon thefinancial and accounting functions clearly understood and adequately addressed.

vii.         Ensuring that thepurchasing, order fulfillment and customer service departments areappropriately staffed and increasing communication and training so that theright purchasing-related information and data is available to the finance andaccounting staff, particularly for transactions where inventory is shippeddirectly from our vendors to our customers.

viii.     Re-engineering thefulfillment of customer orders process through a number of initiatives,including increased use of automation to capture and record informationcritical for ensuring proper accounting treatment of the underlyingtransactions.

We primarily began these remediation steps subsequentto December 31, 2005 and expect to finalize them by the end of the secondquarter of 2006.

The Audit Committee of the Board of Directors has beenactively involved with our assessment of our internal controls environment andthe above material weakness conclusions. They are being continually updated asto our remediation progress, and we would expect this communication to continueuntil all control deficiency issues are addressed and remediated to theirsatisfaction.

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**Report of Ernst &Young LLP,Independent Registered Public Accounting Firm,on Internal Control over Financial Reporting**

To the Board of Directors and Stockholders of GTSICorp.

We have audited management’s assessment, included inthe accompanying Management’s Report on Internal Control Over FinancialReporting, that GTSI Corp. did not maintain effective internal control overfinancial reporting as of December 31, 2005, because of the effect ofcertain material weaknesses described below, based on criteria established inInternal Control—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (the “COSO criteria”). GTSI Corp.’smanagement is responsible for maintaining effective internal control overfinancial reporting and for its assessment of the effectiveness of internalcontrol over financial reporting. Our responsibility is to express an opinionon management’s assessment and an opinion on the effectiveness of GTSI Corp.’sinternal control over financial reporting based on our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining anunderstanding of internal control over financial reporting, evaluatingmanagement’s assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinion.

A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

A material weaknessis a control deficiency, or combination of control deficiencies, that resultsin more than a remote likelihood that a material misstatement of the annual orinterim financial statements will not be prevented or detected. The followingmaterial weaknesses have been identified and included in management’sassessment as of December 31, 2005:

·       GTSIas of December 31, 2005 and for a period of time prior to that date, hadan insufficient number of finance and accounting staff and some of the Company’sfinance and accounting staff lacked sufficient training and expertise in areassuch as accounting for leasing transactions, revenue recognition for services,and income taxes.

·       GTSIhad insufficient controls over the quarterly and year-end financial close andreporting process. This deficiency was exacerbated by the finance andaccounting staffing material weakness as noted above, and was manifestedprimarily in control deficiencies in the accounting for inventory 

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valuation, customerreturns, revenue recognition (including leasing and professional servicestransactions), accruals and the tax provision, all which required post-closingadjustments to inventory, accounts payable, accounts receivable, accruedliabilities, sales, cost of sales and taxes in the fourth quarter of 2005.

·       GTSIhad insufficient execution and oversight related to its customer orderfulfillment process during 2005, which resulted in restatements to all theinterim periods in 2005 as well as adjustments at year-end. Specifically, the Companyerroneously recorded sales, cost of goods sold, accounts receivable andaccounts payable in incorrect reporting periods during 2005 due to a number offactors including inadequate training, inappropriate data entry, vendor payablereconciliations not being performed on a timely basis, lack of oversight andcommunication within the appropriate departments, and significant employee andmanagement turnover within many of the impacted areas.

The combination of the above factors resulted inerrors in the preparation of the 2005 interim and annual financial statementsin the areas of inventory valuation, accounts payable, accounts receivable,sales, and cost of sales, and resulted in a number of post-closing adjustmentsto the Company’s consolidated financial statements as of and for the year endedDecember 31, 2005 and restatement of its interim financial statements forthe quarters ended March 31, 2005, June 30, 2005 and September 30,2005. Until these deficiencies are remediated, there is more than a remotelikelihood that a material misstatement to the annual or interim consolidatedfinancial statements could occur and not be prevented or detected by theCompany’s controls in a timely manner. These material weaknesses wereconsidered in determining the nature, timing, and extent of audit tests appliedin our audit of the consolidated financial statements as of and for the yearended December 31, 2005, and this report does not affect our report dated April 10,2006 on those financial statements.

In ouropinion, management’s assessment that GTSI Corp. did not maintain effectiveinternal control over financial reporting as of December 31, 2005, isfairly stated, in all material respects, based on the COSO control criteria.Also, in our opinion, because of the effect of the material weaknessesdescribed above on the achievement of the objectives of the control criteria,GTSI Corp. did not maintain effective internal control over financial reportingas of December 31, 2005, based on the COSO control criteria.

|                 | /s/ Ernst & Young  LLP |
|----------------------|---------------------------------|
| McLean, Virginia     |                            |
| April 10,  2006 |                            |

 

**ITEM 9B.**       OTHERINFORMATION

None.

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**PART III**

**ITEM 10.**         DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT

The information requiredby this Item is incorporated by reference to the sections of the Registrant’sdefinitive Proxy Statement for the Annual Meeting of Stockholders scheduled tobe held on May 9,2006 (the “Proxy Statement”) entitled “Proposal 1 - Election ofDirectors,” “Continuing Directors,” “Executive Officers,” “Board of Directors,Committees and Corporate Governance,” “Code of Ethics,” “Certain Relationshipsand Related Transactions” and “Section 16(A) Beneficial OwnershipReporting Compliance”. The Proxy Statement will be filed with the Commissionwithin 120 days after December 31, 2005.

**ITEM 11.**         EXECUTIVECOMPENSATION

The information requiredby this Item is incorporated by reference to the sections of the ProxyStatement entitled “Executive Compensation and Other Information,” “Compensationof Directors,” “Employment Agreements and Termination of Employment and Changeof Control Arrangements,” “Performance Graph” and “Compensation CommitteeReport on Executive Compensation.”

**ITEM 12.**         SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information regarding the security ownership ofcertain beneficial owners and management required by this Item is incorporatedby reference to the section of the Proxy Statement entitled “Common StockOwnership of Principal Stockholders and Management.”

The information requiredby Item 201(d) of Regulation S-K is provided under Item 5, Market forRegistrants Common Equity, Related Stockholder Matters and Issuer Purchases ofEquity Securities, which is incorporated herein by reference.

**ITEM 13.**         CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS

The information requiredby this Item is incorporated by reference to the section of the Proxy Statemententitled “Certain Relationships and Related Transactions.”

**ITEM 14.**         PRINCIPALACCOUNTING FEES AND SERVICES

The information required by this Item is incorporatedby reference to the sections of the Proxy Statement entitled “Audit Fees,” and “IndependentAccountants.”

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**PART IV**

**ITEM 15.**         EXHIBITS,FINANCIAL STATEMENTS AND SCHEDULES, AND REPORTS ON FORM 8-K:

**(a) FinancialStatements**

The consolidated financial statements of GTSI Corp. filedare as follows:

Consolidated Balance Sheets as of December 31,2005 and 2004

Consolidated Statement of Operations for each of thethree years in the period

ended December 31, 2005

Consolidated Statements of Changes in Stockholders’Equity for each of the

three years in the period ended December 31, 2005

Consolidated Statements of Cash Flows for each of thethree years in the period

ended December 31, 2005

Notes to ConsolidatedFinancial Statements

**Financial StatementSchedules**

The financial statement schedules of GTSI Corp. andsubsidiaries filed are as follows:

Schedule II—Valuation and Qualifying Accounts for eachof the three years in the period ended December 31, 2005

All other schedules areomitted because they are not applicable, or the required information is shownin the consolidated financial statements or the notes thereto.

**Exhibits**

The exhibits set forth in the Exhibit Index arefiled as part of this Annual Report on Form 10-K.

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15 (d) of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon April 10, 2006 on its behalf by the undersigned thereunto dulyauthorized.

|        |   | **GTSI CORP.**                                   |
|--------|--------|--------------------------------------------------|
|   | By:    | /s/ JAMES J. LETO                                |
|   |   | James J. Leto                                    |
|   |   | President, Chief Executive Officer, and Director |

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, this report has been signed on April 10, 2006 by thefollowing persons on behalf of the registrant and in the capacities indicated.

| /s/ JAMES J. LETO                                 |   |
|---------------------------------------------------|--------|
| James J. Leto                                     |   |
| President, Chief Executive Officer, and Director  |   |
| (Principal Executive Officer)                     |   |
| /s/ THOMAS A. MUTRYN                              |   |
| Thomas A. Mutryn                                  |   |
| Senior Vice President and Chief Financial Officer |   |
| (Principal Financial and Accounting Officer)      |   |
| /s/ M. DENDY YOUNG                                |   |
| M. Dendy Young                                    |   |
| Chairman of the Board                             |   |
| /s/ THOMAS HEWITT                                 |   |
| Thomas Hewitt                                     |   |
| Director                                          |   |
| /s/ LEE JOHNSON                                   |   |
| Lee Johnson                                       |   |
| Director                                          |   |
| /s/ JOSEPH KEITH  KELLOGG, JR.                    |   |
| Joseph Keith Kellogg, Jr.                    |   |
| Director                                          |   |
| /s/ STEVEN KELMAN                                 |   |
| Steven Kelman                                     |   |
| Director                                          |   |

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| /s/ BARRY REISIG    |   |
|---------------------|--------|
| Barry Reisig        |   |
| Director            |   |
| /s/ JOHN M. TOUPS   |   |
| John M. Toups       |   |
| Director            |   |
| /s/ DANIEL R. YOUNG |   |
| Daniel R. Young     |   |
| Director            |   |

 

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**GTSI CORP.VALUATION AND QUALIFYING ACCOUNTS (In thousands)**

**SCHEDULEII**

| **Years Ended December 31,**         | ** ** | ** ** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|
| *Allowance  for Doubtful Accounts*                  |       |       |       |     |       |     |       |
| Balance at beginning of period                      |       | $          | 1,009      |     | $          | 699      |       | $        | 834        |   |
| Additions—charged to expense or other accounts |       | 1,277      |       | 507      |       | 57       |       |
| Deductions                                          |       | (449       | )          | (197     | )          | (192     | )          |
| Balance at end of period                            |       | $          | 1,837      |     | $          | 1,009    |       | $        | 699        |   |
| *Sales  Returns Allowance(1)*                       |       |       |       |     |       |     |       |
| Balance at beginning of period                      |       | $          | —     |     | $          | —   |       | $        | —     |   |
| Additions—charged to expense or other accounts |       | 10,400     |       | —   |       | —   |       |
| Deductions                                          |       | (1,800     | )          | —   |       | —   |       |
| Balance at end of period                            |       | $          | 8,600      |     | $          | —   |       | $        | —     |   |
| *Deferred  Tax Asset Valuation Allowance*           |       |       |       |     |       |     |       |
| Balance at beginning of period                      |       | $          | —     |     | $          | —   |       | $        | —     |   |
| Additions—charged to expense or other accounts |       | 4,997      |       | —   |       | —   |       |
| Deductions                                          |       | —     |       | —   |       | —   |       |
| Balance at end of period                            |       | $          | 4,997      |     | $          | —   |       | $        | —     |   |

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(1)          The sales returnsallowance is reported as a reduction of Accounts Receivable on the consolidatedbalance sheets.

All other schedules are omitted since the requiredinformation is not present or is not present in amount sufficient to requiresubmission of the schedule, or because the information is included in theconsolidated financial statements or notes thereto.

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**EXHIBITINDEX**

| **Exhibit   Number** | ** ** | ** **                                                                                                                                                                                                                                                       | ** ** | **Description** | ** ** | ** ** |
|----------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|------------|------------|
| 3.1                  |       | Restated  Certificate of Incorporation (1)                                                                                                                                                                                                                       |
| 3.2                  |       | Bylaws, as  amended (4)                                                                                                                                                                                                                                          |
| 10.1                 |       | GTSI Employees’  401(k) Investment Plan, and amendments No. 1, 2 and 3 thereto*(8)                                                                                                                                                                |
| 10.2                 |       | Employee Stock  Purchase Plan, as amended to date*(15)                                                                                                                                                                                                           |
| 10.3                 |       | 1994 Stock Option  Plan, as amended to date*(3)                                                                                                                                                                                                                  |
| 10.4                 |       | Amended and  Restated 1996 Stock Incentive Plan*(12)                                                                                                                                                                                                             |
| 10.5                 |       | 1997 Non-Officer  Stock Option Plan, as amended to date*(3)                                                                                                                                                                                                      |
| 10.6                 |       | Lease dated  August 11, 1995 between the Company and Security Capital Industrial  Trust, and Amendments for distribution center facility (5)                                                                                                                |
| 10.7                 |       | Lease dated  December 10, 1997 between the Company and Petula Associates, Ltd. and  Amendment for headquarters facility (5)                                                                                                                                 |
| 10.8                 |       | Second Amendment  to Deed of Lease dated February 11, 2005 between the Company and AG/ARG  Avion, L.L.C. (successor-in-interest to Petula Associates, Ltd.) for  headquarters facility. (8)                                                                 |
| 10.9                 |       | Employment  Agreement dated January 1, 2001 between the Registrant and M. Dendy  Young*(1)                                                                                                                                                                  |
| 10.10                |       | Credit Facilities  Agreement, dated as of October 23, 2003, among the Registrant, certain  lenders named in such agreement, and GE Commercial Distribution Finance  Corporation, as a Lender and as Agent (6)                                               |
| 10.11                |       | First Amendment  to Credit Facilities Agreement, dated March 12, 2004, among the Company,  certain lenders named in such agreement, and GE Commercial Distribution  Finance Corporation, as a Lender and as Agent (8)                                       |
| 10.12                |       | Second Amendment  to Credit Facilities Agreement, dated as of July 29, 2004, among the  Company, certain lenders named in such agreement and GE Commercial  Distribution Finance Corporation, as a Lender and as Agent (5)                                  |
| 10.13                |       | Third Amendment  to Credit Facilities Agreement, dated as of November 22, 2004, among the  Company, certain lenders named in such agreement and GE Commercial  Distribution Finance Corporation, as a Lender and as Agent (8)                               |
| 10.14                |       | Fourth Amendment  to Credit Facilities Agreement dated as of April 28, 2005 among GTSI,  Technology Logistics, Inc., GE Commercial Distribution Finance  Corporation, as Administrative Agent and a Lender, and the Other Lenders (9)                  |
| 10.15                |       | Fifth Amendment  to Credit Facilities Agreement dated as of August 8, 2005 among GTSI,  Technology Logistics, Inc., GE Commercial Distribution Finance  Corporation, as Administrative Agent and a Lender, and the Other Lenders (10)                  |
| 10.16                |       | Sixth Amendment  to Credit Facilities Agreement dated as of August 15, 2005 among GTSI,  Technology Logistics, Inc., GE Commercial Distribution Finance  Corporation, as Administrative Agent and a Lender, and the Other Lenders (11)                 |
| 10.17                |       | Offer Letter  dated December 31, 2002 between the Registrant and Thomas Mutryn* (3)                                                                                                                                                                         |
| 10.18                |       | Non-Qualified  Stock Option Agreement effective January 28, 2003 between the Registrant  and Thomas Mutryn* (3)                                                                                                                                             |
| 10.19                |       | GTSI Corp. Long  Term Incentive Plan*(7)                                                                                                                                                                                                                         |
| 10.20                |       | GTSI 2005  Executive Incentive Compensation Plan* (8)                                                                                                                                                                                                            |
| 10.21                |       | Form of GTSI  Change of Control Agreement* (8)                                                                                                                                                                                                              |
| 10.22                |       | Form of Letter Agreement signed by Scott W.  Friedlander, Thomas A. Mutryn and Scot Edwards regarding second quarter 2005  bonus payments*(2)                                                                                                               |
| 10.23                |       | Transition Agreement with M. Dendy Young dated  February 15, 2006* (13)                                                                                                                                                                                     |
| 10.24                |       | Seventh Amendment to Credit Facilities Agreement  dated as of November 15, 2005 among GTSI, Technology  Logistics, Inc., GE Commercial Distribution Finance Corporation, as  Administrative Agent and a Lender, and the Other Lenders (filed herewith) |
| 10.25                |       | Forbearance  Agreement in Regards to Credit Facilities Agreement dated as of  February 28, 2006 (16)                                                                                                                                                        |
| 10.26                |       | Employment Agreement  dated February 16, 2006 between the Registrant and James J. Leto* (14)                                                                                                                                                           |
| 14.1                 |       | Code of Ethics  (6)                                                                                                                                                                                                                                              |
| 23.1                 |       | Consent of  Ernst & Young LLP (filed herewith)                                                                                                                                                                                                          |
| 31.1                 |       | Section 302  Certification of Chief Executive Officer (filed herewith)                                                                                                                                                                                      |
| 31.2                 |       | Section 302  Certification of Chief Financial Officer (filed herewith)                                                                                                                                                                                      |
| 32                   |       | Section 906  Certification of Chief Executive Officer and Chief Financial Officer  (filed herewith)                                                                                                                                                         |

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*                    Management contractsand compensatory plans and arrangements required to be filed pursuant to Item 15(c).

(1)          Incorporated byreference to the Registrant’s Annual Report on Form 10-K for theyear ended December 31, 2000, File No. 000-19394.

(2)          Incorporated byreference to the Registrant’s Quarterly Report on Form 10-Q for theperiod ended September 30, 2005.

(3)          Incorporated byreference to the Registrant’s Annual Report on Form 10-K for theyear ended December 31, 2002, File No. 000-19394.

(4)          Incorporated byreference to the Registrant’s Quarterly Report on Form 10-Q for theperiod ended June 30, 2004.

(5)          Incorporated byreference to the Registrant’s Quarterly Report on Form 10-Q for theperiod ended September 30, 2004.

(6)          Incorporated byreference to the Registrant’s Annual Report on Form 10-K for theyear ended December 31, 2003.

(7)          Incorporated byreference to Appendix B of the Registrant’s 2004 Proxy Statement.

(8)          Incorporated byreference to the Registrant’s Annual Report on Form 10-K for theyear ended December 31, 2004.

(9)          Incorporated byreference to the Registrant’s Quarterly Report on Form 10-Q for theperiod ended March 31, 2005.

(10)   Incorporated by reference tothe Registrant’s Quarterly Report on Form 10-Q for the period ended June 30,2005.

(11)   Incorporated by reference tothe Registrant’s Quarterly Report on Form 10-Q/A for the periodended June 30, 2005.

(12)   Incorporated by reference toAppendix A of the Registrant’s 2005 Proxy Statement.

(13)   Incorporated by reference tothe Registrant’s Current Report on Form 8-K dated February 15,2006.

(14)   Incorporated by reference tothe Registrant’s Current Report on Form 8-K dated February 16,2006.

(15)   Incorporated by reference tothe Registrant’s Current Report on Form 8-K dated December 27,2006.

(16)   Incorporated by reference tothe Registrant’s Current Report on Form 8-K/A dated March 17,2006.

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