**UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C.  20549**

**FORM 10-K/A**

**ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

**For the fiscal year endedDecember 31, 2005**

Commission File Number:**   0-19394**

**GTSI Corp.**(Exact name ofregistrant as specified in its charter)

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

 

**703-502-2000**(Registrant’s telephone number, including area code)

Securities registered pursuant to section 12(b) of the Act:   **Common Stock, par value $0.005 per share**

Securities registered pursuant to section 12(g) of the Act:    **None**

Indicate by check mark if the registrant is a well-known seasonedissuer as defined in Rule 405 of the Securities Act.             YES  o         NO  x

Indicate by check mark if the registrant is not required to filereports pursuant to Section 13 or Section 15(d) of the Act.            YES  o         NO  x

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.            YES  o         NO  x

Indicate by check mark if disclosure of delinquent filers pursuant toItem 405 of Regulation S-K is not contained herein, and will not be contained,to the best of registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K.  x

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

| Large accelerated filer   ̈ | Accelerated  filer  x | Non-accelerated  filer   ̈ |
|--------------------------------------|----------------------------|-------------------------------------|

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Act).            YES  o         NO  x

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

The number of shares outstanding of the registrant’s common stock onFebruary 28, 2006 was 9,362,846

DOCUMENTS INCORPORATED BY REFERENCE

Items 10, 11, 12, 13 and 14 of Part III of this Form 10-K/A areincorporated by reference to GTSI’s proxy statement filed with the Securitiesand Exchange Commission in connection with the Annual Meeting of Stockholdersheld on May 9, 2006.

 

----

 

**EXPLANATORY NOTE**

This Amendment to our Annual Report on Form 10-Kfor the year ended December 31, 2005 of GTSI Corp. (“GTSI” or the “Company”) isbeing filed to restate the Company’s consolidated balance sheets as of December31, 2005 and 2004 and its statements of operations, stockholders’ equity andcash flows for the years ended December 31, 2005, 2004, and 2003.   Included in this Form 10-K/A is quarterlyfinancial information within Note 17 to the Consolidated Financial Statements,which amends the quarterly financial information previously filed by theCompany with respect to the quarters ended March 31, 2005 and 2004,June 30, 2005 and 2004, September 30, 2005 and 2004 and December 31,2005 and 2004. The Company does not intend to amend the related Forms 10-Q forthese periods.

The information contained in this Amendment, includingthe financial statements and notes thereto, amends only Items 1, 1A, 6, 7, 8and 9A of our originally filed Annual Report on Form 10-K for the year endedDecember 31, 2005. This Amendment does not reflect events occurring after theoriginal filing date of April 12, 2006, or modify or update those disclosuresthat may have been affected by subsequent events.

During the second half of 2006, the Company concludedthat previously reported financial statement information for the periodsdiscussed above required restatement to correct the accounting for: i) thetransfer of certain receivables to third parties in accordance with Statementof Financial Accounting Standards (“SFAS”) No. 140, *Accountingfor Transfers and Servicing of Financial Assets and Extinguishments ofLiabilities, *(“FAS 140”), ii)overstatement of accounts payable and the related cost of sales, and iii) therecording of miscellaneous accounting adjustments appropriate for the fairpresentation of the financial statements. Following the restatement, income oncertain transferred receivables is being recognized over the term of therespective lease agreements, rather than at the time of transfer, along withthe related interest expense on financed lease debt. In addition, thetransferred receivables, together with related liabilities, are reported in theCompany’s balance sheets following the restatement.

 

----

 

**CONTENTS**
|             |   |      |   |                                                                                                               |   | **Page** |   |
|-------------|--------|-----------|--------|--------------------------------------------------------------------------------------------------------------------|--------|----------|--------|
| PART I      |   | Item 1.   |   | Business                                                                                                           |   | 1        |   |
|        |   | Item  1A. |   | Risk  Factors                                                                                                      |   | 12       |   |
|        |   | Item 1B.  |   | Unresolved Staff  Comments                                                                                         |   | 20       |   |
|        |   | Item  2.  |   | Properties                                                                                                         |   | 20       |   |
|        |   | 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                                                                                           |   | 24       |   |
|        |   | Item 7.   |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                        |   | 26       |   |
|        |   | Item 7A.  |   | Quantitative  and Qualitative Disclosures About Market Risk                                                        |   | 40       |   |
|        |   | Item 8.   |   | Financial  Statements and Supplementary Data                                                                       |   | 41       |   |
|        |   | Item 9.   |   | Changes in and Disagreements With Accountants on  Accounting and Financial Disclosure                              |   | 74       |   |
|        |   | Item 9A.  |   | Controls and Procedures                                                                                            |   | 74       |   |
|        |   | Item  9B. |   | Other  Information                                                                                                 |   | 80       |   |
| PART III    |   | Item 10.  |   | Directors and  Executive Officers of the Registrant                                                                |   | 81       |   |
|        |   | Item 11.  |   | Executive Compensation                                                                                             |   | 81       |   |
|        |   | Item 12.  |   | Security Ownership of Certain Beneficial Owners and  Management                                                    |   | 81       |   |
|        |   | Item 13.  |   | Certain Relationships and Related Transactions                                                                     |   | 81       |   |
|        |   | Item 14.  |   | Principal Accounting Fees and Services                                                                             |   | 81       |   |
|        |   | Item 15.  |   | Exhibits, Financial Statement Schedules, and Reports  on Form 8-K                                                  |   | 82       |   |
|        |   |      |   | Signatures                                                                                                         |   | 83       |   |
| Schedule II |   |      |   | Valuation and Qualifying Accounts                                                                                  |   | 84       |   |
|        |   |      |   | Exhibit  Index                                                                                                     |   | 85       |   |

 

----

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

*Readersare cautioned that this Annual Report on Form 10-K/A contains forward-lookingstatements within the meaning of Section 27A of the Securities Act of 1933, asamended, and Section 21E of the Securities Exchange Act of 1934, as amended, (“ExchangeAct”) relating to our operations that are based on our current expectations,estimates and projections. Words such as “expect,” “believe,” “anticipate,” “plan,”“intend” and similar expressions are used to identify these forward-lookingstatements. These statements are not guarantees of future performance andinvolve risks, uncertainties and assumptions that are difficult to predict. Ouractual results may differ materially from what is expressed or projected in theseforward-looking statements. The reasons for this include the factors discussedin Item 1A, Risk Factors, of this Annual Report on Form 10-K/A. We specificallydisclaim any obligation to update these forward-looking statements. Theseforward-looking statements should not be relied on as representing ourestimates or views as of any subsequent date.*

**PART I**

**ITEM 1.           BUSINESS**

**Overview**

Founded in 1983,GTSI Corp. is a Delaware corporation with more than 20 years of experiencefocused exclusively on selling IT products and solutions to U.S. Federal, stateand local governments. We use the terms “GTSI,” “we,” “our,” and “us” to referto GTSI Corp. and its subsidiaries. During this period, our customers have cometo rely on GTSI to translate business challenges into practical technologysolutions for today’s governments. We harness IT’s leading vendors, productsand services inside the core technology areas most critical to governmentsuccess. “GTSI” is a registered service mark of GTSI Corp. All other trademarksand service marks are proprietary to their respective owners.

We sell todepartments and agencies of the U.S. Federal Government, as well as state andlocal governments, and prime contractors. Our total sales were $882.0 million,$1.1 billion and $951.5 million for the years ended December 31, 2005, 2004 and2003, respectively. Weoffer a competitive mix of logistical and procurement support to our customers.The approximate percentage of our sales by customer type for the yearsended 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      | %          |

 

Additionalinformation related to net (loss) income, total assets, significant customersand long-lived assets is provided in the consolidated financial statements andin Note 15 of the consolidated financial statements appearing in Part II, Item8 of this Annual Report on Form 10-K/A.

We faced severalchallenges during 2005 as a result of a changing government marketplace, theimplementation of our GTSI Enterprise Management System (“GEMS”), and employeeturnover. In response, at the end of 2005 management reaffirmed its goal topursue a distinctive business model that combines the concepts of a value addedreseller of complex IT solutions with an efficient reseller of more

1

----

commodity-likeproducts. We believe this fusion will create a strong and solid governmenttechnology partner.

The vast majorityof the IT solutions we offer to our customers have a strong product component,and many are entirely product-based. The latter are identified and purchased bygovernment procurement officers under standard government contracts, whichrange from single agency contracts to those which are available to the entireU.S. Federal Government or state government community (such as U.S.Communities). We are especially well-positioned to fulfill the requirement ofhaving an appropriate contract vehicle as we hold a contracts portfolio thatincludes nearly four dozen such contracts, and many major Federalagency-specific contracts.

To fulfill productdemand, GTSI maintains a 140,000 square-feet distribution and integrationcenter in NorthernVirginia, immediately adjacent to Washington Dulles International Airport. Weuse this proximity in concert with close systems relationships with ourcustomers and vendors to assure timely delivery for our customers’mission-critical applications. We leverage our distribution and integrationcenter and matching logistics expertise to offer a wide variety of managedfulfillment and value added services such as:

·                  Hardware integration;

·                  Customer image propagation;

·                  Automated system diagnostics and datacapture;

·                  Customer asset tagging; and

·                  Complex configurations of various ITSolutions, such as Voice over Internet Protocol.

Both our distribution and integration operations areISO 9001:2000 certified.

To help our customers acquire, manage and refreshthis technology in a strategic and application-appropriate manner, GTSI hascreated a mix of financial services capable of managing the entire technologylifecycle. GTSI offers lease arrangements to allow government agencies toacquire access to technology as an evenly distributed operating expense, ratherthan the much more budget-sensitive and discontinuous capital expenses. This isespecially important to agencies whose budget planning requirements span manyforward-looking years, but whose technology needs cannot be accurately plannedon the same timeline. It also appropriately helps agencies keep theirinformation management resources focused on the flow and security of agencyinformation, rather than ownership of the technology itself. This model is inhigh demand from our customers, and we believe it represents a distinctive GTSIsolutions advantage.

**GoingConcern**

Our independentregistered public accounting firm, Ernst & Young LLP, has concluded thatsubstantial doubt exists about our ability to continue as a going concern, andhas included that conclusion in its audit report on our consolidated financialstatements for the year ended December 31, 2005 included in this Annual Reporton Form 10-K/A. GTSI incurred a net loss of $13.7 million for the year endedDecember 31, 2005 and has not complied with certain covenants of our $135 million revolving credit facility with agroup of banks (the “Credit Facility”). Our lenders have notified usthat our Credit Facility will terminate on the annual renewal date of May 31,2006. As a result, we will need a replacement credit facility to meet ourcapital needs for the remainder of 2006 and beyond.

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

2

----

Credit Facility.We did not include any adjustments to the consolidated financial statementsincluded in this Form 10-K/A to reflect the possible future effects that mayresult from the uncertainty of our ability to continue as a going concernbecause we are confident that we will continue to be a financially sound andviable business, providing quality service to our government customers,attractive employment opportunities for our employees and long-term value toour stockholders. We expect to obtain a replacement credit facility in the nearfuture and we believe we are taking the necessary actions to improve our cashflows. We are currently undertaking the following efforts to address thisuncertainty:

·                  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;

·                  We are workingto strengthen the core operating processes of the supply chain and improveproductivity;

·                  We initiatedsignificant reductions in workforce in October 2005 and February 2006 to reduceour costs, eliminating over 100 full time positions;

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

·                  Inthe fourth quarter of 2005, we developed a strategic plan to identify and exitfailing or non-strategic activities, improve execution of our current business,and emerge as a high-value solutions provider, as described in our BusinessStrategy section below.

**Business Strategy**

GTSI is committedto and focused on the government customer. We believe there are significantopportunities to realize improved profitability through our existing business,and to increase our relatively low market share within the growing governmentIT market.

Our vision is tobecome a leading supplier of IT solutions to our government customers, and tocontinue taking advantage of the robust government IT market. During 2005,management created a plan with three elements consistent with our goals: toidentify and exit failing or non-strategic activities, improve execution of thecurrent business, and emerge as a high value solutions-provider. These elementsare detailed below.

*Identifyand Exit Failing or Non-Strategic Activities*

We expect to bemore successful 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 and asecond in February 2006. We continue to measure the performance of variouscustomer teams and lines of business, and adjust our resources to ensure thatthey are being deployed to maximum advantage.

*ImproveExecution*

Our goal continuesto be to create margin improvement through process improvement and costreductions. The implementation of the GEMS system in 2005 put significantstrain on our organization and exposed several process inefficienciesthroughout GTSI. We believe we can reduce operating costs, improve customerservice and improve cash flow through a concerted effort to improve our supplychain and delivery processes. We recently aligned our organization to put allsupply-chain and IT activities in one organization to drive the variousinitiatives to realize the benefits of improved execution. We have

3

----

begun to mapvarious processes and will be taking additional action intended to improve ourcurrent business activities.

*Emerge asa High-Value Solutions Provider*

GTSI continues toevolve as a provider of value-added solutions consisting of both products andservices to our government and system integrator customers. We have beensuccessful in providing technical assistance to support complex, multi-vendorsolutions; in providing GTSI and third-party services; and in teaming withother service providers on large, more complex bids. While larger salestransactions represent a small percentage of our total transactions, theyrepresent the majority of our margin and profits. Going forward, we willcontinue to focus on these larger, more profitable transactions, and driveprocesses and changes to make the delivery of the smaller transactions moreprofitable. In addition, we will continue to take other action to create andmaintain a profitable company. Specifically, we plan to:

*Focus on the Growing Government IT Market*

Because of our historicalfocus on government, GTSI has developed the expertise and established thevendor and customer relationships necessary to be a leader in this market. As aresult, our marketing and sales force are effective at reaching and servicingthe government 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.

*ExecuteNew Government Contracts and Utilize Flexible Contract Vehicles*

GTSI holds a wide rangeof government contracts, including multi-million dollar, multi-year contractswith the Department of Defense (“DoD”) and various civilian agencies, as wellas several multiple award schedules and blanket purchasing agreements with avariety of DoD and civilian agencies. We also serve as a subcontractor,providing products and services to other companies holding governmentcontracts. GTSI intends to continue identifying and pursuing contract vehiclesthat best leverage our broad selection of solutions, services, integration anddistribution capabilities and vendor relationships.

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

In addition to offering afull line of computer hardware, software and peripheral products, GTSI offersits customers pre- and post-sale technical support and assistance in theselection, configuration, installation and maintenance of the products andsystems that we sell. Furthermore, by offering a range of IT solutions andproducts through a variety of procurement mechanisms, we offer our customersthe convenience, flexibility and cost savings of purchasing from a centralizedsource. In our interactions with our customers, our employees focus onproviding high quality customer services associated with the order, delivery,installation and repair of the products we sell. In addition to our productofferings, we now offer service solutions to meet our customer needs innetworking and telecommunications, storage and continuity of operationssolutions, enterprise software deployment, and managed logistics support.

*Establish and Maintain Strong Vendor Relationships*

To provide acentralized source of products and solutions for our customers, GTSI maintainsstrong relationships with leading hardware, software and services vendors. GTSIoffers our vendors a wide range of marketing and sales services, which providethem with access to the millions of end-users constituting the governmentmarket. In addition, we insulate our vendors from the procurement regulatorycomplexities, costs and complicated billing requirements associated with thegovernment market.

4

----

**Customers**

GTSI’s sales arepredominantly generated from multiple agencies and departments of the U.S.Federal Government, either directly or ultimately through prime contractors.Our sales from the U.S. Federal Government (both directly and indirectly)accounted for approximately 92%, 95%, and 97% of our sales during 2005, 2004and 2003, respectively. U.S. Federal Government sales were earned from numerousagencies 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 itssales through 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.

*GeneralServices Administration*

GTSI holds a GSAdesignated Schedule 70 contract for the sale of IT products and services.Schedule 70 contracts are multi-award schedule contracts managed by the GSA ITAcquisition Center. In March 2002, the U.S. Federal Government formallyexercised its first of three five-year options to extend the GTSI contractthrough 2007. GSA contracts provide all government agencies, certaininternational organizations, authorized prime contractors, and state and localgovernments with an efficient and cost-effective means for buying commercialproducts. GSA purchasers may place unlimited orders for products under GSAcontracts.

Our GSA contractcontains price reduction clauses requiring that we pass on to governmentcustomers certain reduced prices we may receive from our vendors, but prohibitsus from passing 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 contractsoffer greater flexibility than GSA contracts because they allow products to beadded quickly and allow contractors more pricing flexibility. IDIQ contractsare pre-competed; therefore, orders

5

----

placed under thesecontracts are not subject to formal protest unless the order is beyond thescope of the contract. There are three types of IDIQ contracts: government-wideacquisition contracts (“GWAC”), multi-agency contracts (“MAC”), and singleagency contracts. A GWAC is a task-order or delivery-order contract forinformation 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.

Details regarding 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)        |

----

(a) Comprises three contracts which each relate to a specific categoryof IT products

(b) National Institute of Health

(c) Contract containsextension options

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

*BlanketPurchase Agreements*

Individual GSAordering agencies may enter into GSA-authorized BPAs with GSA contract holders.BPAs are similar to second-tier contracts under a contractor’s GSA contract.BPAs enable agencies to obtain better pricing based on volume ordering and theydecrease an agency’s administrative costs by streamlining the ordering process.

 

GTSI maintainsseveral Federal Supply Schedule BPAs that are authorized under our GSA Schedule70 contract. GSA authorized BPAs incorporate many terms, conditions andproducts offered on GSA Schedule contracts, often at prices lower than thoseavailable on the GSA schedules. We normally enter into separate agreements withvendors to offer reduced BPA prices to the government. Our BPAs are agencyspecific and allow us to focus specific vendor relationships on specificcustomers.

*State andLocal*

In 2003, GTSI wasawarded U.S. Communities, a multi-state contract available to cities, counties,special districts (airport, water, etc.), state agencies, schools and largenon-profits such as hospitals and clinics. In addition, GSA now allows stateand local government agencies to utilize GSA Schedules. Multi-state contractsenable individual states to utilize the buying power of multiple states, whichresults in lower costs based on volume purchasing. The initial term of the U.S.Communities contract expires on May 1, 2006 and the contract has three one-yearextension options.

The products aresold under the contract at a fixed price; however, governments typicallynegotiate a lower price for large quantity or high value orders. In addition,these contracts include an administrative fee calculated on the product price.We collect this fee and remit it on a quarterly basis to the contract’sadministering agency.

Many purchases inthe state and local government market are still made through individualcompetitive procurements, although many state and local governments issue invitationsto bid 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

6

----

required tosuccessfully market and sell to individual states. GTSI currently maintainsseveral state and local IT contracts, regularly submits oral and written bidsto state and local governments and is on a number of state and local governmentbid lists.

*Open Market*

We also sell manyIT products through open market procurements. These procurements are separateand apart 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, Solutions and Services**

GTSI continuouslymonitors and evaluates existing and emerging technologies to ensure that theyoffer our customers the most appropriate technology for their demandingapplications. GTSI also offers simplified buying to our customers through oure-commerce website, GTSI.com, as well as a growing number of agency, programand vendor-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 providesoftware products from most leading desktop and enterprise software providers,including Adobe, BEA Systems, Citrix Systems, Computer Associates, IBM, McAfee,Mercury Interactive, Microsoft Corporation, Red Hat, Symantec/Veritas, andVMWare. GTSI’s stable of software provider relationships is both broad andstrong.

*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;

·                  Mandates foragency migration to next-generation networks, including support for IPv6 andVoIP;

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

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

7

----

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

Each GTSI solutionstarts with standard components built around a custom deployment model that isdetermined through our assessment of the customer’s complete applicationenvironment. This action plan draws on approaches and technology created acrossmany of our projects to help drive any given project to rapid delivery. It isthis combination of core services and approaches that we believe best helps ourcustomers meet their critical budget and deadline requirements.

A typical GTSI solution may draw from any of thesecore services:

·                  Needs analysis and environment assessment;

·                  Professional services, including projectplanning and management, engineering, implementation and training;

·                  Financial services to evenly distribute cashflow requirements for technology refreshes and buying cycles;

·                  Systems integration and configuration,including code load and light assembly; and

·                  Managedfulfillment across multiple products and locations.

GTSI providesthese services with technology embedded in off-the-shelf products drawn from acore pool of industry-technology innovators. This pool currently includesPanasonic Computer Company, Cisco Systems, Sun Microsystems, Hewlett-PackardDevelopment Company (HP), International Business Machines (IBM), SiliconGraphics, Inc. (SGI), Network Appliance, Apple Computer, American PowerConversion Corporation (APC), and Microsoft Corporation, among many others.

*Servicesand Warranty*

We professionallymanage the creation and delivery of all services to our customers either usingour internal resources or subcontracting to a third-party service provider.GTSI typically offers warranties on products for the same term as themanufacturer’s warranty. We also sell extended warranties ranging from three tofive years beyond the manufacturer’s warranty on certain products.

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  (restated)** | ** ** | **2004  (restated)** | ** ** | **2003  (restated)** | ** ** |
|--------------------------------------|------------|----------------------|------------|----------------------|------------|----------------------|------------|
|                                 |       |                 |       |                 |       |                 |       |   |   |   |   |   |   |
| Hardware                             |       | $                    | 706.7      |                 | 80.1       | %                    | $          | 833.4 |   | 77.5 | % | $ | 689.9 |   | 72.5 | % |
| Software                             |       | 117.8                |       | 13.4                 |       | 155.7                |       | 14.5 |   | 154.5 |   | 16.2 |   |
| Resold third-party  service products |       | 37.2                 |       | 4.2                  |       | 66.6                 |       | 6.2 |   | 91.2 |   | 9.6 |   |
| Services                             |       | 20.3                 |       | 2.3                  |       | 19.7                 |       | 1.8 |   | 15.9 |   | 1.7 |   |
| Total                                |       | $                    | 882.0      |                 | 100.0      | %                    | $          | 1,075.4 |   | 100.0 | % | $ | 951.5 |   | 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:

·                  Proactive salesof products and solutions;

8

----

·                  Access to thegovernment market through a significant number of diverse contract vehicles;

·                  Helping to lowercosts to comply with procurement regulations involved in selling directly tothe government market; and

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

The terms ofagreements with our vendors vary widely, but typically permit us to purchaseproducts for resale (with subsequent system integration and professionalservices as needed) to the government market. Virtually none of our agreementsrequire us to purchase any specified quantity of product. GTSI typicallyrequires vendors, acting as suppliers to us under our term governmentcontracts, to provide us with supply and price protection for the duration ofsuch contracts. Other than supply agreements under term government contracts,our vendor agreements are typically terminable by GTSI or the vendor on shortnotice, at will or immediately upon default by either party, and may containlimitations on vendor liability. These vendor agreements also generally permitGTSI to return previous product purchases at no charge within certain timelimits for a restocking fee or in exchange for other products of such vendor.

Our vendorsprovide us with 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.

**Inventory Management**

We purchaseproducts for resale both directly from manufacturers and indirectly throughdistributors and other sources. During 2005, we purchased approximately 75% of theproducts we sold directly from manufacturers and the remaining amount fromdistributors and other sources. Our distribution process is highly automatedwith a real-time shipment tracking and status system. All product picking isperformed using bar-coded labels, UPC bar codes and radio frequency scanning.We implemented an RFID Solution in January 2005, which enables us to apply RFIDtags to case and pallet-load shipments that meet published DoD requirements. Wehave dedicated teams to perform cycle counts, process customer returns andreceive products.

We generally shipproducts by UPS, FedEx, Conway and other commercial delivery services and,where applicable, invoice customers for shipping charges.

**Marketing and Sales**

Our marketingdepartment develops and manages our branding and positioning activities, whichspan all print, electronic and live media within our target market. Theseactivities inform our government customers and prospects of our capabilitiesand the GTSI value proposition, helping us acquire new customers and retainexisting business relationships. Many of these activities are funded by ourvendors in exchange for the market entry that GTSI relationships and expertiseoffer in selling to the government.

Our marketingactivities include sponsorship of major trade shows, private customer-educationevents, display advertising in print and broadcast media, corporate andsolutions-focused collateral, the GTSI.com e-commerce Web site, targeted e-mailmarketing, outbound telemarketing, and sales-related incentive programs.

9

----

We recognize thatthe size and diversity of the government market make it imperative for us toidentify and understand the needs of our customers. Through years of intensiveeffort, GTSI has compiled and maintained a proprietary database that containsan extensive list of agency procurement and contracting officers, informationresource managers, senior policy makers, technology influencers, end-users,systems integrators, value added resellers and prime contractors. We use thisdatabase to target our marketing efforts and perform data mining for variousmarket research purposes.

Our salesorganization is focused on understanding the current and emerging needs of ourcustomers and to provide products, services and bundled solutions to meet thoseneeds. Our sales organization continues to provide deep coverage for existingcustomers while expanding sales coverage to focus on new accounts and newproduct and service offerings to current customers.

**Competition**

The government ITmarket is highly competitive, and subject to rapid change. GTSI competes with anumber of competitors, including traditional hardware and software resellers,systems integrators, commercial computer retail chains and distributors.

We believe thatthe principal competitive factors in the government IT market are:

·                  Price (forhighly commoditized technology);

·                  Expertise ingovernment 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 traditional reseller portion of our business hasconsolidated and intensified. Pricing pressure in particular has been andremains intense. We believe that price competition will continue to increase in 2006, as consolidationcontinues and competitors rationalize their complete supply chain. Thiscompetition may require us in some cases to reduce prices, increase advertisingexpenditures or undertake other actions to retain our strategic position.Decreasing prices require us to sell a greater number of products to achievethe same level of sales and gross margin. If this trend continues and we are unableto attract new customers and sell increased quantities of products or modifyour strategy, our future sales and gross margins may be adversely affected.

Scale and scope are important dimensions in the government technologysupply chain. A number of competitors to our system integration businessare much larger than GTSI, and have far greater financial, marketing andtechnological resources. This difference in scale could in some cases produce amaterial impact on the promotional and sales support requirements of ourbusiness. We believe we have a competitive advantage over certain of ourcompetitors because of our strong brand among government customers, ourextensive contract portfolio and our wide variety of vendors.

**Backlog**

We identify anorder as backlog as soon as we receive and accept a written customer purchaseorder. 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 ordersthat have not shipped (“unshipped backlog”) as well as orders that have shippedbut

10

----

cannot berecognized as revenue at the end of the reporting period, since title passes toour customers when the orders reach the destination. Total backlog as ofDecember 31, 2005 was $134.7 million compared to $86.8 million as of December31, 2004. Unshipped backlog as of December 31, 2005 was approximately $126.0million, compared to $81.5 million as of December 31, 2004.

**Employees**

At March 17, 2006we had 732 employees, including 506 in sales, marketing and professionalservices; 40 in operations; and 186 in finance, IT, contracts and legal, andother support functions. None of our employees are represented by a labor unionand we have experienced no labor-related work stoppages.

**AvailableInformation**

GTSI is traded onthe NASDAQ National Market under the symbol GTSI (See Item 5 of this AnnualReport on Form 10-K/A). Our annual reports on Form 10-K, quarterly reports onForm 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 made available freeof charge on our web site at www.gtsi.com as soon as reasonably practicableafter we electronically file such material with, or furnish it to, theSecurities and Exchange Commission. All of GTSI’s current required Exchange Actfilings with the SEC, as well as press releases and other investor relations’information, may be obtained free of charge by request to: Investor Relations,GTSI Corp., 3901 Stonecroft Boulevard, Chantilly, VA 20151-1010. Telephone(703) 502-2540.

 

11

----

**ITEM 1A.        RISKFACTORS**

There are many factors that affect our business and results ofoperations, some of which are beyond our control. The following is adescription of some important factors that may cause actual results to differmaterially from those in forward-looking statements and from historical trends.

***We are uncertain of our ability to meet thecovenants under our Credit Facility in future periods and we are uncertain ofour ability to obtain alternative financing for our future capital needs.  If we fail to be in compliance with anymaterial provision or covenant of our Credit Facility or are unable to obtainalternative financing, we may not be able to continue to operate our business.***

In February 2006, we received a notice of default from our lenders ofcertain covenants under our Credit Facility. As of January 31, 2006 we defaulted on the following financial covenantsunder the Credit Facility: (i) maximum funded indebtedness to EBITDA, (ii)minimum EBIT to net sales, and (iii) minimum tangible net worth.  Our lenders requested the execution of anagreement to temporarily forbear them from enforcing their rights and remediesas a result of the events of default. On April 3, 2006, we defaulted on anothercovenant under the Credit Agreement when we received a staff determinationletter from The NASDAQ National Market stating that because we had not filedour Annual Report on Form 10-K for 2005 with the SEC, as required by MarketPlace Rule 4310(c)(14), GTSI’s common stock is subject to delisting from theNASDAQ 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 expect to avoid delisting of our commonstock from The NASDAQ National Market by the filing of this Form 10-K.  A forbearance agreement (“Credit Agreement”),effective February 28, 2006, was executed between GTSI and our lenders on March10, 2006.

The covenants of our Credit Agreement impose certain operatingrestrictions and financial and reporting covenants on us. These restrictionsand conditions may affect our ability to operate our business and may limit ourability to take advantage of potential 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

·                  Engage a restructuring advisor to, amongother things, evaluate our financial plans and alternatives.

Our ability to comply with these covenants may be affected by eventsbeyond our control, and unanticipated events could require us to seek waiversor amendments of covenants or alternative sources of financing or to reduceexpenditures. We cannot assure you that such waivers, amendments or alternativefinancing could be obtained, or if obtained, would be on terms acceptable tous.

A breach of any of the covenants or restrictions contained in ourCredit Agreement could result in an event of default under that agreement. Wecannot assure you that we will be able to comply with the covenants to which weare subject in the future and, if we fail to do so, that we will be able toobtain waivers from our lenders or amend the covenants.  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, we cannot assure you that we will have sufficientfunds available to pay in full the total amount of obligations that become dueas a result of any such acceleration, or that we will be able to findadditional or alternative financing to refinance any such acceleratedobligations.

12

----

We are currently in negotiations with several leading financialinstitutions seeking to secure long-term financing.  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. Wecannot assure you that any such funds will be available to us on favorableterms or at all.  If such funds areunavailable to us, we may not have enough cash to meet our operating needs.

***Infrastructure failures could have a materialadverse effect on our business.***

We are highly dependent on our infrastructure to process orders, trackinventory, ship products in a timely manner, prepare invoices to our customers,recognize revenue and otherwise carry on our business in the ordinary course.The implementation of GEMS resulted in problems which disrupted our businessand adversely affected our sales and margins.

InApril of 2005, GTSI went live with a new supply chain management system basedon software provided by Peoplesoft Corporation, the GTSI Enterprise ManagementSystem (“GEMS”).  Management had plannedextensively for this implementation, and had invested a considerable sum ofmoney training associates from a variety of functional disciplines throughoutthe supply chain.

Forthe first 90 days after go-live, we encountered many significant issues inevery area of the supply chain.  Theseissues resulted in significant productivity issues that we spent the rest ofthe year recovering from.  Dozens of bugfixes and patches to the software were required.  While the software was operatingsignificantly better after the first 90 days, many core processes were notfully stabilized and were not as efficient as with the previous system.  For the remainder of the year, a significantnumber of enhancements and additional reporting capabilities were added whichenabled management to make better decisions based on the information available.  As of December 31, 2005, core processes werestabilized with many active programs underway to continue to improve coreprocesses during 2006.

The ongoing use of GEMS 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 financialcondition were adversely affected during 2005 and could continue to be impactedin future periods.

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

We are exposed to inventory risks as a result of balancing the need tomaintain appropriate inventory levels to ensure competitive lead times againstthe risk of inventory obsolescence because of rapidly changing technology andcustomer requirements. We seek to minimize our inventory exposure through avariety of inventory management procedures and policies, vendor priceprotection and product return programs. Additionally, more than one-half of ourproduct sales are shipped directly from our vendors to our customers.

However, as a result of difficulties in our implementation of GEMS andthe related distraction of employees from managing sales returns and inventorylevels, excess inventory began to accumulate in the second quarter of 2005.  Management became aware of the magnitude ofthis issue during the fourth

13

----

quarter of 2005, performed analyses and refocused our attention oneffective 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, ifwe determine that we have additional inventory exposure, we may have to reduceour prices or write-down additional inventory, which in turn could result inlower gross margins.

***We face certain risks as a result of changes in ourmanagement team, including our Chief Executive Officer, who resigned February15, 2006.***

Our success depends in large part on the contributions of ourmanagement team. Over the past few years, we have experienced significantchanges in our management team. For example, the following executivesterminated their relationship with GTSI: our Senior Vice President of Sales inJuly 2005; our Senior Vice President, Program and Information Services inFebruary 2005; our former President and Chief Operating Officer in May 2004;and our former Controller in May 2004. Although we do not believe that thedeparture of any one of these individuals had a significant negative impact onour business, we face operational challenges as a result of this turnoverbecause some members of our management team are still learning about ourcompany operations. If we do not succeed in solving the operational challengeswe face in connection with the changes to our management team, we could suffera significantly adverse impact on the development 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 financial statements for theyear ended December 31, 2005, management identified three material weaknessesin our internal control over financial reporting that existed as of December31, 2005, which resulted in errors in our 2005 financial statements andrequired a restatement of our consolidated financial statements for the firstthree quarters of 2005. Additional errors were discovered subsequent to thefiling of our Annual Report on Form 10-K, which resulted in the restatement ofour consolidated financial statements for 2005, 2004 and 2003 contained in thisAnnual Report on Form 10-K/A. As a result, management identified two additionalmaterial weaknesses that existed as of December 31, 2005. A material weaknessis a control deficiency, or combination of control deficiencies, which resultsin more 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 onForm 10-K/A for a description of these material weaknesses.

Although we are currently in the process of implementing remediationmeasures to correct these material weaknesses, we can provide no assurance thatwe will be successful in these efforts or that the remediation measures willresult in our having adequate internal control over financial reporting in thefuture. In addition, we cannot assure you that we will not in the futureidentify further deficiencies or weaknesses in our internal control overfinancial reporting. If we are unable to adequately remediate our materialweaknesses and maintain an effective system of internal control, our ability totimely and accurately report financial results may continue to be adverselyaffected, which could have a material adverse effect on our ability to operateour business. Any failure to file periodic reports on a timely basis could havemany consequences, including: potential delisting from NASDAQ, which wouldsignificantly impair the ability of our investors to buy and sell shares; lackof the timely disclosure to the market of our financial results; actions by theSEC against us for failure to comply with applicable Federal securities laws;our inability to use certain short form registration statements; and an eventof default under the credit agreement with our lenders which would cancel ourCredit Facility and cause all outstanding loan 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.

14

----

We will need to hire and successfully integrate additional qualifiedpersonnel in our accounting, finance, and operations functions to handle theincreased complexity of our business related to the increase in professionalservices sales and increasingly sophisticated leasing transactions. If weencounter difficulties in attracting or retaining qualified accounting staff,we may not be able to remedy the identified material weakness in our financialclose and reporting process. The current employment market for qualifiedindividuals with accounting backgrounds is very competitive, and we mayencounter difficulty in identifying, attracting or retaining such individuals.If we are unable to successfully fill our open positions and increase thetechnical accounting expertise of our accounting function, we may not be ableto remedy the identified 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 staff determination letter from TheNASDAQ National Market stating that because GTSI has not filed its AnnualReport on Form 10-K for 2005 with the SEC, as required by Market Place Rule4310(c)(14), GTSI’s common stock is subject to delisting from the NASDAQNational Market.  GTSI has requested ahearing with NASDAQ which should stay the delisting pending the determinationof NASDAQ’s hearing panel.  While thereis no assurance, we expect to avoid delisting of its common stock from TheNASDAQ National Market by the filing of our Form 10-K for 2005 with the SECbefore delisting would otherwise take effect.

In addition, our remediation of certain material weaknesses in ourinternal controls over financial reporting will require extensive timeconsuming manual processing, which may, in the future, delay completion of ourquarterly unaudited consolidated financial statements. This may prevent us fromtimely filing our reports under the Exchange Act, which would also be aviolation of NASDAQ Marketplace Rule 4310(c)(14), and would subject us topotential delisting in the future. If our common stock were to be delisted as aresult of our 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.

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

Our profitability is a function of our ability to generate sales,improve our efficiency, and control costs. We plan our operating expense levelsbased primarily on forecasted sales levels. These expenses and the impact of long-term commitments are relativelyfixed in the short-term. A short fall in sales could lead to operating resultsbeing below expectations because we may not be able to quickly reduce our fixedexpenses in response to short term business changes.  In response to sales short falls during theyear ended December 31, 2005, we announced reduction in workforce actions inOctober 2005 and February 2006 resulting in the elimination of over 100employee positions. Significant risks associated with reductions in workforceinclude decreases in employee morale and the failure to meet operationaltargets due to the loss of employees.

During the year ended December 31, 2005 we incurred significant costsdue to excess and obsolete inventory, increasing sales returns, significantemployee turnover, and the impairment of our deferred tax asset.  In addition, costs increased in ouraccounting department, and are expected to continue in 2006, related to therestatement of prior quarterly results, increased audit fees due to materialweaknesses in internal control over financial reporting and the resulting priorperiod restatements, expansion of the quantity and level of technical expertiseof accounting personnel, and the on-going remediation of significantdeficiencies and material weaknesses in internal control.

If we are unable to control our costs or generate sales to cover thecosts required to run our business and correct our material weaknesses ininternal control over financial reporting, our net losses will continue and ourbusiness could be adversely affected.

15

----

***Our auditor’s report states that the operatinglosses and our potential inability to obtain a new revolving credit facilityraise substantial doubt about GTSI’s ability to continue as a going concern.***

Our independent registered public accounting firm, Ernst & YoungLLP, has concluded that substantial doubt exists about our ability to continueas a going concern and has included that conclusion in its audit report  on our consolidated financial statements forthe year ended December 31, 2005 included in this Annual Report on Form10-K/A.  Ernst & Young LLP’s conclusionis based on our net loss of $13.7 million, the use of $109.5 million of cash inoperating activities for the year ended December 31, 2005, and the currentstatus of our Credit Facility. Our lenders have notified us that ourCredit Facility will terminate on the annual renewal date of May 31, 2006. As aresult, we will need a replacement credit facility to meet our working capitalneeds for the remainder of 2006 and beyond. On April 10, 2006 we signed a commitment letter to negotiate a newrevolving credit facility with two major money center banks by May 31, 2006,the expiration date of the current Credit Facility.  No assurance can be given that we will besuccessful in obtaining any such financing on acceptable terms, if at all.

The “going concern” opinion may cause concern to one or more of ourconstituencies of employees, stockholders, customers, vendors, or tradecreditors. If any customer’s, vendor’s or trade creditor’s concern changestheir business relations with us by stopping work, ceasing sales, requiringsales on cash terms or other changes, these changes may materially adverselyaffect our cash flows and results of operations.

***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 and departments to providea substantial portion of our sales either directly or through prime contractorswith which we work. We have derived, and believe that we will continue toderive, a significant portion of our sales from a limited number of projectsand transactions with the U.S. Federal Government. For the year ended December31, 2005, approximately 3% of our largest customer purchase orders representedapproximately 80% of our gross margins. The completion or cancellation of alarge project or a significant reduction in scope would significantly reduceour gross margins. In addition, if we fail to secure an equal number of largetransactions in the future, our results will be negatively impacted.

We have four major contracts that are up for re-compete in 2006.  As a result of our recent delivery issues dueto the implementation of the final phase of GEMS, we are not certain that wewill obtain the re-competed awards. During 2005, these contracts represented approximately 40% of our salesand 35% of our gross margins. Any dispute, failure to exercise an extension, orcontract not renewed as a result of a re-compete could have a material adverseimpact on our future operating results 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 our business from one which resells commodity ITproducts to one which provides value-added solutions to our governmentcustomers.  A number of risks areinherent in this strategy.  We may not beable to successfully transform our workforce into one which has the technicalskills to provide more complex technology to customers.  Services and solutions require differentinternal accounting, tracking, and project management procedures, and there isno assurance we will be able to develop and implement those necessaryprocedures.  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.  We alsowill need to develop certain internal technical capabilities to identify,develop, market and sell more complex solutions, and there is no assurance wewill be successful in these endeavors.

16

----

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

Changing laws, regulations and standards relating to corporategovernance and public disclosure, including the Sarbanes-Oxley Act of 2002, newSEC regulations and NASDAQ National Market rules, are creating uncertainty forcompanies such as ours. These new or changed laws, regulations and standardsare subject to varying interpretations, in many cases due to their lack ofspecificity, and as a result their application in practice may evolve over timeas new guidance is provided by regulatory and governing bodies. This couldresult in higher costs necessitated by ongoing revisions to disclosure andgovernance practices. As a result, our efforts to comply with evolving laws,regulations and standards have resulted in, and are likely to continue toresult in, increased selling, general and administrative expense and adiversion of management’s time and attention from revenue-generating activitiesto compliance activities. In particular, our efforts to comply with Section 404of the Sarbanes-Oxley Act of 2002 and the related regulations regarding ourrequired assessment of internal control over financial reporting and our externalauditors’ audit of that assessment require the commitment of significantfinancial and managerial resources. Further, our Board members, Chief ExecutiveOfficer and Chief Financial Officer could face an increased risk of personalliability in connection with the performance of their duties. As a result, wemay have difficulty attracting and retaining qualified Board members andexecutive officers, which could harm our business.

***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 in large part on the continued services of ourmanagement and key employees. The loss of the services of key personnel couldhave a material adverse impact on our operations. Our future success will alsodepend on our ability to attract and retain highly skilled personnel, includingfinance and accounting staff, to replace personnel who leave. In addition tothe low unemployment rate in the Washington, DC metropolitan area, competitionfor experienced management, finance professionals, and technical, sales andsupport personnel in the IT industry is substantial. During the year endedDecember 31, 2005, our annual voluntary turnover rate for total staff wasapproximately 30%. Coupled with our reductions in force and other involuntaryterminations, turnover exceeded 40% during 2005. If we continue to experiencethe loss of a significant number of our employees in the future, it couldadversely affect our operating results, including our ability to obtain andsuccessfully complete customer engagements or effectively compete.  To attract and retain employees, we may haveto increase our compensation levels or incur higher recruiting costs in thefuture. This would adversely affect our financial performance.

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

Our sales, operating results and cash flows have been, and are expectedto continue to be, subject to significant fluctuations from quarter to quarterdue to a number of factors 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;

·                  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

·                  Changes in accounting rules, such asrecording expenses for employee stock option grants and tax accountingprinciples.

17

----

Our recent level of product gross margins may not be sustainable.  In addition, changes in services gross marginmay result from various factors such as changes in the mix between technicalsupport services and advanced services, as well as the timing of servicecontract initiations and renewals.  As aconsequence, sales volumes and operating results for future periods aredifficult to predict and, therefore, prior results are not necessarilyindicative of results to be expected in future 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 our services to our customers through variousthird-party service providers engaged to perform these services on our behalf.In addition, we outsource parts of our operations to third-parties and maycontinue to explore opportunities to outsource others. In these engagements, wemay engage subcontractors or we may act as subcontractor to the primecontractor of an engagement. In the event these third parties fail to maintainadequate levels of support, do not provide high quality services or cease orreduce operations, our business, operations, customer relations and sales maybe negatively impacted and we may be required to pursue replacement third-partyrelationships, which we may not be able to obtain on as favorable terms or atall. In addition, the inability to negotiate terms of a contract with a thirdparty, the refusal or inability of these third parties to permit continued useof their services by us, or the termination by the client or prime contractorof our services or the services of a key subcontractor would harm our operatingresults.

***Any issue that compromises our relationship withagencies of the U.S. Federal Government would cause serious harm to ourbusiness.***

Our sales are highly dependent on the government’s demand for ITproducts. Direct and indirect sales to numerous agencies and departments of theU.S. Federal Government accounted for 92%, 95% and 97% of our sales in 2005,2004 and 2003, respectively. We believe that U.S. Federal Government contractswill continue to be a source of the majority of our sales for the foreseeablefuture. For this reason, any issue that compromises our relationship withagencies of the U.S. Federal Government would cause serious harm to ourbusiness. A material decline in overall sales to the U.S. Federal Government asa whole, or to certain key agencies thereof, could have a materially adverseeffect on our results of operations. Among the key factors in maintaining ourrelationships 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.

To the extent that our performance does not meet customer expectations,or our reputation or relationships deteriorate, this would cause a negativeeffect on our sales, profitability and cash flow. Noncompliance with governmentprocurement regulations or contract provisions could result in substantialmonetary fines or damages, suspension or debarment from doing business with theU.S. Federal Government, and civil or criminal liability.

Substantially allof our government contracts are terminable at any time at the government’sconvenience or 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.

18

----

***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 highly competitive and areserved by numerous international, national and local firms. We may not be ableto compete effectively in these markets. Market participants include traditionalhardware and software resellers, systems integrators, commercial computerretail chains and distributors.Some of these competitors have significantly greater financial, technical andmarketing resources, generate greater sales and have greater name recognitionthan we do. In addition, there are relatively low barriers to entry into the ITmarket, and we have faced, and expect to continue to face, additionalcompetition from new entrants into the IT market.

We believe our ability to compete also depends in part on a number ofcompetitive factors, including:

·                  Expertise ingovernment procurement processes where standardized contracts exist;

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

·                  Technicalexpertise;

·                  Logistical capability;

·                  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

·                  the extent of our competitors’ responsivenessto client needs.

If we are unable to compete effectively we could experience continuedoperating losses and our market share may decline, adversely affecting ourresults of operations and financial condition.

***We may not qualify as a small business for newcontract awards****.*

GTSI maintains a “small business” status under its GSA Schedulecontract, ITES contract and several BPAs it held in 2005 based upon its sizestatus at the time of the contracts’ original award date. As a small business,GTSI enjoys a number of benefits, including being able to compete for smallbusiness orders, qualifying as a small business subcontractor, bidding pursuantto small purchase procedures directed to non-manufacturer small business, andoffering government agencies an avenue to meet their internal small businesspurchase 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 referenced in a solicitation, GTSI may or may not qualify as asmall business for new contract awards. Under a Federal Acquisition Regulation (FAR) Deviation issued onOctober 10, 2002 by GSA, GTSI will be required to recertify its size status onits GSA Schedule Contract no later than 2007. At such time, GTSI may notqualify as a small business for new orders under the GSA Schedule. In addition,new legislation or regulations may require GTSI to recertify its size status onits GSA Schedule sooner than 2007. We cannot predict whether we would continueto qualify as a small 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. Federal Government spending policies or budgetpriorities could directly affect our financial performance. Among the factorsthat could materially harm our business 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

·                  delays in the payment of our invoices bygovernment payment offices.

19

----

The U.S. Federal Government’s overall information technology spendingfor the 2007 fiscal year was announced to be $64 billion.  This represents an increase of 2.8% overfiscal year 2006, a significant reduction over the five to six percent increasesreceived in recent years.  These or otherfactors could cause U.S. Federal Government agencies and departments to reducetheir purchases under contracts, to exercise their right to terminatecontracts, or not to exercise options to renew contracts, any of which wouldcause 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-term strategy may include identifying and acquiring, investingin or merging with suitable candidates on acceptable terms. In particular, overtime, we may acquire, make investments in, or merge with providers of productofferings that complement our business. Acquisitions include a number of risksand present financial, 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

·                  acquisition financing may not be available onreasonable terms or at all.

Any acquired business, technology, service or product couldsignificantly under-perform relative to our expectations, and we may notachieve the benefits we expect from our acquisitions. For all these reasons,our pursuit of an acquisition, investment or merger could cause our actualresults to differ materially from those anticipated.

**ITEM1B.        UNRESOLVED STAFF COMMENTS**

Not applicable.

**ITEM 2.          PROPERTIES**

GTSI’s primary business is conducted from a headquarters anddistribution center located in Northern Virginia. We do not own any realproperty. Our headquarters are located in office space of approximately165,000 square 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 additional informationregarding our obligations under leases, see Note 14 of the consolidatedfinancial statements in Part II, Item 8 of this Form 10-K/A.

20

----

**ITEM 3.           LEGAL PROCEEDINGS**

InNovember 2003, GTSI was served with a $25 million lawsuit, with treble damages,related to an alleged breach of contract due to the termination of Ichiban,Inc., a former subcontractor. This suit was filed in Virginia Circuit Court inFairfax County, Virginia and follows the Company’s earlier lawsuit against theformer subcontractor. The case was decided in the Company’s favor resulting inan award of $1.4 million in attorneys’ fees and costs. The plaintiff filedan appeal in October 2005 which the Supreme Court of Virginia refused onFebruary 17, 2006. The plaintiff has filed a petition for a rehearing with theSupreme Court of Virginia.

**ITEM 4.           SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

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

 

21

----

**PART II**

**ITEM 5.****                                 ****MARKET FOR REGISTRANT’S COMMONEQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES**

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

**PriceRange of Common Stock**

GTSI’s common stock is traded on the NASDAQ National Market under thesymbol GTSI. On April 3, 2006, we received a staff determination letter fromthe NASDAQ National Market stating that because GTSI has not filed the 2005Annual Report on Form 10-K with the SEC, as required by Market Place Rule4310(c)(14), GTSI’s common stock is subject to delisting from the NASDAQNational Market.  GTSI has requested ahearing with NASDAQ which should stay the delisting pending the determinationof NASDAQ’s hearing panel.  While thereis no assurance, we expect to avoid delisting of our common stock from theNASDAQ National Market by the filing this Form 10-K with the SEC.

As of April 7, 2006, there were 330 stockholders ofrecord of the Company’s common stock. The following stock prices are the highand low sales prices of GTSI’s common stock during the calendar quartersindicated.

 

| 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 hasnever paid any cash dividends and does not anticipate paying cash dividends onits common stock in the foreseeable future. GTSI’s CreditFacility discussed under Part II, Item 8, Note 9 to the consolidated financialstatements of this Annual Report on Form 10-K/A prohibits the payment ofdividends.

**IssuerPurchases of Equity Securities**

GTSI made the following purchases of its common stock during the fourthquarter of 2005:
| **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 |   |
|                                              |            |                                              |            |                                                    |            |                                                                                                                  |            |                                                                                                                                    |            |  |  |

 

22

----

GTSI’s commonstock purchase program was announced in February 2000. GTSI’s Board ofDirectors authorized GTSI to repurchase its common stock for an aggregatepurchase price up to $5.25 million. In January 2002 and April 2005, GTSI’sBoard of Directors authorized additional purchases to increase the aggregatepurchase amount to $10 million. This purchase program, as increased, is theonly 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 as limitations on the purchase of GTSI’sstock.  Due to the terms of the Credit Agreement entered into as aresult of events of default as of January 31, 2006, the Company is currentlyrestricted from purchasing its stock.

**Equity Compensation Plans**

The following table summarizes information regarding GTSI’s equitycompensation plans 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    |   |

----

*****Representsshares issuable under options granted from time to time to persons notpreviously employed by the Company, as an inducement essential to such personsentering into employment agreements with the Company.

For a description of the other material features of the Company’sequity compensation plans, see Note 10 of the notes to consolidated financialstatements in Item 8 of this Annual Report on Form 10-K/A.

23

----

**ITEM 6.           SELECTED FINANCIAL DATA**

As more fully described in Note 3 of the consolidated financialstatements appearing in Part II, Item 8 of this Annual Report on Form 10-K/A,the previously issued financial information contained herein for the yearsended December 31, 2005, 2004 and 2003 have been restated to correct theaccounting for the transfer of certain receivables, overstatement of accountspayable and related cost of sales, and the recording of other accountingadjustments appropriate for the fair presentation of the financial statements.

The following selected consolidated financial data, which has beenrestated as noted above, is qualified in its entirety by reference to, andshould be read in conjunction with, the audited consolidated financialstatements and related notes and Management’s Discussion and Analysis ofFinancial Condition and Results of Operations. The statement of operations dataset forth below for the three years ended December 31, 2005, 2004 and 2003 andthe balance sheet data as of December 31, 2005 and 2004 has been derived fromGTSI’s audited consolidated financial statements which are included in Part II,Item 8 of this Annual Report on Form 10-K/A. The balance sheet data as ofDecember 31, 2003 is derived from audited consolidated financial statements ofGTSI, as restated, and not included herein. The selected consolidated financialdata for the years ended December 31, 2002 and 2001 was derived from GTSI’saudited consolidated financial statements.

Our (loss) income from operations, net (loss) income and (loss)earnings per share for the years ended December 31, 2005 and 2004 werematerially affected by certain items, which affects the comparability of theinformation presented with other years’ results. Cost of sales for the yearended December 31, 2005 included the positive effects of a change in estimateof vendor payable amounts of $1.6 million which was offset by a $5.6 millioncharge recorded in cost of sales to write-down inventory to its market value asdiscussed in Note 7 to the consolidated financial statements. In addition, costof sales for the year ended December 31, 2004 included the positive effects ofthe derecognition of aged accrued payables of $10.1 million and a change inestimate of vendor payable amounts of $2.5 million as discussed in Note 1 tothe consolidated financial statements. This resulted in an increase of $12.6million to gross margin and income from operations for the year ended December31, 2004. As a result of these items, loss from operations for the year endedDecember 31, 2005 was $4.0 million lower and income from operations for theyear ended December 31, 2004 was $12.1 million higher. All notes referenced arein Item 8 of this Annual Report on Form 10-K/A.

24

----

 
| **Statement of Operations Data:**                   | ** ** | **For the years ended December 31,** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| **(in thousands, except per share data)** | ** ** | **2005**                                                      | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                         | ** ** | **(restated)**                                                | ** ** | **(restated)** | ** ** | **(restated)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Sales                                                              |       | $                                                             | 882,012    |   | $ | 1,075,437 |   | $ | 951,511 |   | $ | 934,730 |   | $ | 783,496 |   |
| Cost of sales                                                      |       | 782,210                                                       |       | 953,345 |   | 853,354 |   | 857,105 |   | 718,370 |   |
| Gross margin                                                       |       | 99,802                                                        |       | 122,092 |   | 98,157 |   | 77,625 |   | 65,126 |   |
| Operating expenses:                                                |       |                                                          |       |   |   |   |   |   |   |   |   |
| Selling, general  and administrative                               |       | 115,121                                                       |       | 106,993 |   | 86,332 |   | 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                                          |       | 120,352                                                       |       | 110,015 |   | 95,178 |   | 66,499 |   | 61,409 |   |
| (Loss) income from  operations                                     |       | (20,550                                                       | )          | 12,077 |   | 2,979 |   | 11,126 |   | 3,717 |   |
| Interest and other  income, net                                    |       | 3,651                                                         |       | 4,916 |   | 2,937 |   | 4,520 |   | 3,707 |   |
| (Loss) income before  income taxes                                 |       | (16,899                                                       | )          | 16,993 |   | 5,916 |   | 15,646 |   | 7,424 |   |
| Income tax benefit  (provision)                                    |       | 3,226                                                         |       | (6,858 | ) | (2,598 | ) | (6,113 | ) | (2,938 | ) |
| Net (loss) income                                                  |       | $                                                             | (13,673    | ) | $ | 10,135 |   | $ | 3,318 |   | $ | 9,533 |   | $ | 4,486 |   |
| (Loss) earnings per  common share                                  |       |                                                          |       |   |   |   |   |   |   |   |   |
| Basic                                                              |       | $                                                             | (1.49      | ) | $ | 1.17 |   | $ | 0.40 |   | $ | 1.15 |   | $ | 0.55 |   |
| Diluted                                                            |       | $                                                             | (1.49      | ) | $ | 1.05 |   | $ | 0.36 |   | $ | 1.04 |   | $ | 0.50 |   |
| Weighted average common  shares outstanding                        |       |                                                          |       |   |   |   |   |   |   |   |   |
| Basic                                                              |       | 9,166                                                         |       | 8,664 |   | 8,343 |   | 8,302 |   | 8,144 |   |
| Diluted                                                            |       | 9,166                                                         |       | 9,618 |   | 9,308 |   | 9,156 |   | 9,049 |   |

 
| **Balance Sheet Data:**           | ** ** | **As of December 31,** | ** ** |
|-----------------------------------|------------|------------------------|------------|
| **(in thousands)**                | ** ** | **2005**               | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                        | ** ** | **(restated)**         | ** ** | **(restated)** | ** ** | **(restated)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Working capital                   |       | $                      | 60,208     |   | $ | 79,014 |   | $ | 65,306 |   | $ | 62,836 |   | $ | 34,968 |   |
| Total assets                      |       | $                      | 345,907    |   | $ | 313,908 |   | $ | 279,487 |   | $ | 224,918 |   | $ | 252,452 |   |
| Borrowings under credit  facility |       | $                      | 48,014     |   | $ | 1,168 |   | $ | 12,813 |   | $ | 7,539 |   | $ | 20,186 |   |
| Long-term liabilities             |       | $                      | 19,072     |   | $ | 13,099 |   | $ | 5,606 |   | $ | 1,640 |   | $ | 2,403 |   |
| Total liabilities                 |       | $                      | 267,740    |   | $ | 221,493 |   | $ | 201,135 |   | $ | 149,427 |   | $ | 189,387 |   |
| Stockholders’ equity         |       | $                      | 78,167     |   | $ | 92,415 |   | $ | 78,352 |   | $ | 75,491 |   | $ | 63,065 |   |

 

 

25

----

 

**ITEM7.           MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

Thefollowing discussion and analysis is provided to increase the understanding of,and should be read in conjunction with, our audited consolidated financial statementsand notes included in Part II, Item 8 of this Annual Report on Form 10-K/A.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**

Duringthe second half of 2006, management concluded that GTSI’s financial statementsfor the years ended December 31, 2005, 2004 and 2003 should be restated tocorrect the accounting for the transfer of receivables, the overstatement ofaccounts payable and related cost of sales, and the recording of miscellaneousaccounting adjustments appropriate for the fair presentation of the financialstatements. As a result of the corrections of these errors, we restated ourfinancial statements as described more fully in Note 3 of the consolidatedfinancial statements in this Form 10-K/A. Following the restatement, income oncertain transferred receivables is being recognized over the term of therespective lease agreements, along with interest expense on financed leasedebt. These restatements resulted in a decrease to net loss of $2.3 million, adecrease to net income of $0.1 million and an increase to net income of $0.1million for the years ended December 31, 2005, 2004 and 2003, respectively.Loss per share for the year ended December 31, 2005 decreased by $0.25. Basicand diluted earnings per share for the year ended December 31, 2004 decreasedby $0.01 and $0.04, respectively. Basic and diluted earnings per share for theyear ended December 31, 2003 increased by $0.02 and $0.01, respectively. Inaddition, the transferred receivables together with related liabilities arereported in GTSI’s balance sheets following the restatement. These restatemententries resulted in an increase of $39.3 million and $17.5 million in totalassets as of December 31, 2005 and 2004, respectively and total liabilitiesincreased $35.8 million as of December 31, 2005 and $17.2 million as ofDecember 31, 2004. Additionally, the restatement entries affected the Statementof Cash Flows by moving an equal amount of cash flows from operations to cashflows from financing activities, resulting in a reclassification of $68.8million and $30.0 million for the years ended December 31, 2005 and 2004,respectively. This Management’s Discussion and Analysis of Financial Conditionand Results of Operations has been modified and updated to reflect the effectof these restatements.

Includedin this Form 10-K/A is quarterly financial information within Note 17 to theConsolidated Financial Statements, which amends the quarterly reports on Form10-Q, previously filed by the Company with respect to the quarters endedMarch 31, 2005 and 2004, June 30, 2005 and 2004, September 30,2005 and 2004 and December 31, 2005 and 2004.

**GoingConcern**

Our independentregistered public accounting firm, Ernst & Young LLP, has concluded thatsubstantial doubt exists about our ability to continue as a going concern, andhas included that conclusion in its audit report on our consolidated financialstatements for the year ended December 31, 2005 included in this Annual Reporton Form 10-K/A. We incurred a net loss of $13.7 million and used $109.5 millionin cash for operating activities for the year ended December 31, 2005.  In addition, we have not complied withcertain covenants of our Credit Facility as of January 31, 2006. A breach ofany of the covenants or restrictions contained in the Credit Facility wouldresult in an event of default.  Such adefault could allow the lenders to discontinue lending or declare allborrowings 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 acceleratedobligations. Our lenders have notified 

26

----

us that our CreditFacility will terminate on the annual renewal date of May 31, 2006.  As a result, we will need a replacementcredit facility to meet our capital needs for the remainder of 2006 and 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/A to reflect the possible future effects that mayresult from the uncertainty of our ability to continue as a going concernbecause we are confident that we will continue to be a financially sound andviable business, providing quality service to our government customers,attractive employment opportunities for our employees and long-term value toour stockholders.  We expect to obtain areplacement credit facility in the near future and we are taking the necessaryactions to improve our cash flows. We are currently undertaking the followingefforts to address this uncertainty:

·                  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;

·                  We are workingto strengthen the core operating processes of the supply chain and improveproductivity;

·                  We have concertedefforts underway to improve working capital by collecting aged receivables,increasing the amount of partial billings and invoicing customers as soon asallowed; and

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

In the fourth quarter of 2005, we developed astrategic multi-element plan to identify and exit failing or non-strategicactivities, improve execution of the current business, and emerge as a highvalue solutions-provider. While we are confident in our plans for 2006, we recognize thechallenges we face in winning new contracts, winning re-competes of existingcontracts, and satisfying our customers and vendors.  We believe that our strategic plan willcreate positive momentum and help us return to profitability.

**Overview**

GTSIhas more than 20 years of experience in selling IT products and solutionsprimarily to U.S. Federal Government customers. We believe our keydifferentiators to be our strong brand among government customers, extensivecontract portfolio and wide variety of vendors.

The vast majorityof the IT solutions we offer to our customers have a strong product component,and many are entirely product-based. We connect IT’s leading vendors, products and services inside the coretechnology areas most critical to government success by partnering with globalIT leaders such as Panasonic, HP, Cisco, Sun Microsystems and Microsoft. Inour traditional 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 products;and a wide range of peripherals.

During 2005, wefocused on application areas in which our government customers haveconsistently demonstrated the greatest immediate strategic interest, and whichprovide us with the greatest opportunity for 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.

27

----

To help our customers acquire, manage and refreshthis technology in a strategic and application-appropriate manner, GTSI hascreated a mix of financial services capable of managing the entire technologylifecycle. GTSI offers leasing arrangements to allow government agencies toacquire access to technology as an evenly distributed operating expense, ratherthan the much more budget-sensitive and discontinuous capital expenses. Thismodel is in high demand from our customers, and we believe it represents adistinctive advantage. We expect to continue to expand our sales from leasingarrangements for IT products and solutions in 2006.

InApril of 2005, GTSI went live with a new supply chain management system basedon software provided by Peoplesoft Corporation, the GTSI Enterprise ManagementSystem (“GEMS”).  Management had plannedextensively for this implementation, and had invested a considerable sum ofmoney training associates from a variety of functional disciplines throughoutthe supply chain.

Forthe first 90 days after go-live, we encountered many significant issues inevery area of the supply chain.  Theseissues resulted in significant productivity issues that we spent the rest ofthe year recovering from.  Dozens of bugfixes and patches to the software were required.  While the software was operatingsignificantly better after the first 90 days, many core processes were notfully stabilized and were not as efficient as with the previous system.  For the remainder of the year, a significantnumber of enhancements and additional reporting capabilities were added whichenabled management to make better decisions based on the informationavailable.  As of December 31, 2005, coreprocesses were stabilized with many active programs underway to continue toimprove core processes during 2006.

Asdiscussed in more detail in our MD&A:

·                  Our sales decreased approximately $193.4million, or 18.0%, from 2004 to 2005;

·                  We recorded a $5.6 million charge forinventory valuation at the lower of cost or market;

·                  Our net loss for the year ended December 31,2005 was $13.7 million;

·                  Cash used in operations totaled $109.5million;

·                  We recorded prior period adjustments to ourpreviously issued 2005, 2004 and 2003 quarterly financial statements; however,

·                  Our balance sheet remains solid, with nolong-term debt.

We are looking forward to significant improvementsin operational and financial performance through a combination of additionalsales and improved margin percentages. We have put in place a multi-elementplan to move the business from lower margin product sales to higher marginsolutions sales. In the first element of our plan, we identified and exitedfailing or non-strategic activities, including two reductions in workforcetotaling over 100 full time positions and realigning functions throughout theCompany to increase margin improvement through cost reductions.  In the second and third elements of our plan,which will progress throughout 2006, we will work to improve execution of thecurrent business and deliver high value solutions. We believe there aresignificant opportunities to increase our relatively low market share withinthe growing government IT market as we pursue a distinctive business modelcombining the concepts of a value added provider of complex IT solutions with atraditional reseller.

**Critical Accounting Estimates and Policies**

The discussion and analysis of our financial condition and results ofoperations is based on our consolidated financial statements, which have beenprepared in accordance with U.S. generally accepted accounting principles. Thepreparation of these financial statements requires management to makeestimates, judgments and assumptions that affect the reported amounts of assetsand liabilities and 

28

----

disclosure of contingent assets and liabilities at the date of theconsolidated financial statements and the reported amounts of revenue andexpenses during the reporting period. Actual results may differ from theseestimates under different assumptions or conditions. Critical accountingestimates are defined as those that are reflective of significant judgments anduncertainties, and potentially result in materially different results underdifferent assumptions and conditions. We have included below our policies thatare both important to our financial condition and operating results, andrequire management’s most subjective and complex judgments in determining theunderlying estimates and assumptions.

The following list of critical accounting estimates and policies is notintended to be a comprehensive list of all of our accounting policies. Oursignificant accounting policies are more fully described in Note 1 to ourconsolidated financial statements in Item 8 of this Annual Report on Form10-K/A. Accounting policies and estimates that management believes are mostimportant to our financial condition and require management’s significantjudgments and estimates pertain to revenue recognition, transfer ofreceivables, valuation of inventory, capitalized internal use software,accounts payable and income taxes. We have discussed the application of thesecritical accounting estimates and policies with the Audit Committee of ourBoard of Directors.

*RevenueRecognition*

We recognize revenue when persuasive evidence of a sale arrangementexists, delivery has occurred or services have been rendered, the sales priceis fixed or determinable, and collectibility is reasonably assured. Themajority of our sales relates to physical products and is generally recognizedwhen title and risk of loss to the products sold passes to the customer. Basedon our standard shipping terms, title generally passes upon the customer’sreceipt of the products. This requires us to analyze sales near the end ofreporting periods to estimate the amount of products in transit to the customerthat cannot be recognized as revenue. Many of our sales of physical productsare shipped to our customers directly from our vendor partners. The accuraterecording of revenue for these transactions relies upon the accuracy ofshipment dates we receive from our vendors and is subject to additionalestimates and judgments by management.

When a customer order contains multiple itemssuch as hardware, software, and services that are delivered at varying times,significant judgment is required to determine whether the delivered items can be consideredseparate units of accounting and if so, how the price should be allocated amongthe deliverable elements and when to recognize revenue for each element.  We also offer lease arrangements to customers to acquiretechnology. These arrangementstypically have terms from two to four years and are generally accounted for assales-type leases under FAS No. 13, *Accounting for Leases*,(“FAS 13”).

Certain of our service and solution agreements require significantrevenue recognition estimates including progress towards completion and totalestimated costs to complete. Revenues on professional service contracts aregenerally recognized using the proportional-performance basis of accounting.For some professional services engagements the completed-performance method isused when the services to be performed in the last series of acts is sosignificant in relation to the entire service contract that performance isdeemed not to have occurred until the final act is completed, or there arecustomer-specified subjective acceptance criteria.

At the time of sale, we record an estimate for product returns based onhistorical experience. Management reviews the assumptions regarding the lagtime and volume of sales returns at least on a quarterly basis, and changes inthe estimates are recorded in the period in which they occur.

*FinancingReceivables*

We enter into complex agreements with our customers to provide ITsolutions with payment terms spread over generally a two to four year period.Usually GTSI monetizes these future revenue streams into cash receipts fromthird party financial institutions. We have master service agreements withmultiple lenders 

29

----

each with varying terms. These agreements, as well as the individualtransaction agreements, require significant analysis to determine whether thetransfer of the receivable should be accounted for as a sale or a securedborrowing with pledge of collateral based on the FAS 140 criteria that requiresGTSI to effectively surrender control over the asset. The technical accountingand legal requirements involved are complex and subject to interpretation.Significant judgment is required to determine whether GTSI has effectivelysurrendered control over the asset. If certain criteria are met and control issurrendered, the transaction is recorded as a sale and the gain on the sale isrecognized in other income. If the transfer is deemed not to meet the criteriafor a sale, the transaction is reported as a secured borrowing with pledge ofcollateral. The collateral remains on our balance sheet and income on thetransfer is recognized ratably over the term of the agreement. Differingconclusions in these statements could impact total assets, total liabilities,lease-related income, and earnings (loss) per share on our consolidatedfinancial statements.

Management determined that certain transferred receivables previouslyaccounted for as sales of financial assets did not meet the criteria for a saleand has restated its 2005, 2004 and 2003 financial statements to reflect thefinancing receivable and related financed lease debt as assets and liabilitiesand to recognize the income on certain financing receivables over the life ofthe related agreement. Following the restatement, income on certaintransferred receivables is being recognized over the term of the respectivelease agreements, along with interest expense on financed lease debt. As discussed further in Note 3 to ourconsolidated financial statements in Part II, Item 8 of this Annual Report onForm 10-K/A, this resulted in a decrease in interest and other income, net of$3.1 million and $0.7 million for the years ended December 31, 2005 and 2004,respectively, and an increase of $0.1 million for the year ended December 31,2003. In addition, the transferred receivables together with relatedliabilities are reported in GTSI’s balance sheets following the restatement.These restatement entries resulted in an increase of $39.3 million and $17.5million in total assets as of December 31, 2005 and 2004, respectively andtotal liabilities increased $35.8 million as of December 31, 2005 and $17.2million as of December 31, 2004.

*Inventory*

Our inventory is stated at the lower of average cost or market value. Wereduce the value of our inventory for excess and obsolete inventory based onassumptions about future demand and market conditions. Our estimates of futureproduct demand may prove to be inaccurate, in which case we may haveunderstated or overstated the provision required for excess or obsoleteinventory.  In the future, if there werea higher incidence of inventory obsolescence because of rapidly changingtechnology and customer requirements, we would be required to increase ourexpense to write-down inventory to market value and our gross margin could beadversely affected.

During 2005, due to the difficulties arising from theimplementation of GEMS including ordering excess inventory and distraction ofpersonnel from the management of procurement and inventory, we recorded animpairment charge of $5.6 million for obsolete and excess inventory, whichreduced our gross margin by the same amount. During 2004 as a result ofour physical inventory counts and other internal controls, we discovered twoinstances of inventory losses which resulted in a charge to cost of sales of$0.7 million, net of insurance settlement.

*CapitalizedInternal Use Software*

Significant judgment isrequired to determine what expenditures qualify for capitalization of internaluse software.  Subsequent additions,modifications or upgrades to internal-use software are capitalized only to theextent that they allow the software to perform a task that it previously didnot 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.

Duringthe year ended December 31, 2005 management decided to use a web-based customerresource 

30

----

management(“CRM”) software instead of the CRM module of GEMS. As a result, we testedcertain asset groupings within GEMS for recoverability and recorded animpairment loss of approximately $1.0 million, net of accumulated amortization,in operating expenses to write down GEMS to its fair value. During the yearended December 31, 2003 we changed our strategy regarding GEMS from a highlycustomized enterprise resource planning (“ERP”) system to a standard ERP systemto compress the delivery time and provide significant value sooner. Due to thischange in strategy, we recorded an impairment charge of approximately $6.0million for capitalized customization expenses determined to have no futureeconomic value. If any future events indicate the carrying amount ofGEMS may exceed its fair value, we will test for recoverability which wouldnecessitate the use of significant assumptions regarding the fair value andundiscounted net cash flows expected. During the years ended December 31, 2005and 2004, we capitalized $2.1 million and $5.5 million for GEMS. As of December31, 2005 and 2004 the carrying value of GEMS was $9.1 million and $9.1 million,respectively.

*Accounts Payable*

Wepurchase significant amounts of inventory each year and record an estimate forinventory and the related payable when inventory is received based on thepurchase orders issued as of the balance sheet date and the historic rate ofpurchase price variances, which is analyzed on a quarterly basis. For productsshipped directly from our vendors to our customers, management makessignificant estimates regarding when to record the payable for shipped goods.  Customers receive their products, therebycompleting the revenue cycle and incurring GTSI’s obligation to pay the vendorthe associated costs.  As invoices arereceived, we record adjustments for purchase price variances. Changes in ourestimate of the payable balance may be caused by changes in price between theorder date and the receipt date related to volume discounts, changes in marketrates, or special pricing promotions offered by our vendors. During the yearsended December 31, 2005 and 2004 changes in these estimates increased grossmargin $1.6 million and $2.5 million, respectively.

*Income Taxes*

Determiningour effective tax rate, provision for tax expense, deferred tax assets andliabilities and the related valuation allowance involves judgments and estimates.Deferred income taxes result from temporary differences between the tax basisof assets and liabilities and the basis reported in our consolidated financialstatements. Deferred tax liabilities and assets are determined based on thedifference between financial statement and tax basis of assets and liabilitiesusing enacted rates expected to be in effect during the year in which thedifferences reverse. Valuation allowances are provided against assets,including net operating losses, if it is anticipated that the asset is not morelikely than not to be realized through future taxable earnings orimplementation of tax planning strategies. We record reserves for uncertain taxpositions, which management believes are adequate. We recorded a valuationallowance during 2005 against the full amount of our net deferred tax assets,because in the opinion of management, it is more likely than not that thesedeferred tax assets will not be realized. Our effective tax rate in a givenperiod could be impacted if we determine the allowance is or is not required,or if we were required to pay amounts in excess of established reserves. SeeNote 12 of the consolidated financial statements in Item 8 of this Form 10-K/A.

31

----

**HistoricalResults of Operations**

The following table illustrates the percentage of sales represented byitems in our consolidated statements of operations for the years ended December31:

|                                     | ** ** | **2005**       | ** ** | **2004**       | ** ** | **2003**       | ** ** |
|-------------------------------------|------------|----------------|------------|----------------|------------|----------------|------------|
| ** **                          | ** ** | **(restated)** | ** ** | **(restated)** | ** ** | **(restated)** | ** ** |
| Sales                               |       | 100.0          | %          | 100.0          | %          | 100.0          | %          |
| Cost of sales                       |       | 88.7           |       | 88.7           |       | 89.7           |       |
| Gross margin                        |       | 11.3           |       | 11.3           |       | 10.3           |       |
| Operating  expenses:                |       |           |       |           |       |           |       |
| Selling, general and administrative |       | 13.0           |       | 9.9            |       | 9.1            |       |
| Depreciation and amortization       |       | 0.5            |       | 0.3            |       | 0.3            |       |
| Impairment charge                   |       | 0.1            |       | —         |       | 0.6            |       |
| Total operating  expenses           |       | 13.6           |       | 10.2           |       | 10.0           |       |
| (Loss) income  from operations      |       | (2.3           | )          | 1.1            |       | 0.3            |       |
| Interest and  other income, net     |       | 0.4            |       | 0.5            |       | 0.3            |       |
| (Loss) income  before taxes         |       | (1.9           | )          | 1.6            |       | 0.6            |       |
| Income tax  benefit (provision)     |       | 0.3            |       | (0.7           | )          | (0.3           | )          |
| Net (loss) income                   |       | (1.6           | )%         | 0.9            | %          | 0.3            | %          |

 

Thefollowing table indicates, for the years ended December 31, the approximatesales by vendor and product category along with related percentages of totalsales (dollars in millions).
| **Sales by Vendor** | ** ** | **2005  (restated)** | ** ** | **2004  (restated)** | ** ** | **2003  (restated)** | ** ** |
|-------------------------------|------------|----------------------|------------|----------------------|------------|----------------------|------------|
| Panasonic                     |       | $                    | 179.7      |                 | 20.4       | %                    | $          | 188.0 |   | 17.5 | % | $ | 162.2 |   | 17.0 | % |
| Cisco                         |       | 115.1                |       | 13.1                 |       | 135.7                |       | 12.6 |   | 112.9 |   | 11.9 |   |
| Sun Microsystems              |       | 102.7                |       | 11.6                 |       | 131.8                |       | 12.3 |   | 130.1 |   | 13.7 |   |
| HP                            |       | 85.8                 |       | 9.7                  |       | 153.4                |       | 14.3 |   | 139.3 |   | 14.6 |   |
| Network  Appliance            |       | 30.8                 |       | 3.5                  |       | 13.0                 |       | 1.2 |   | 6.4 |   | 0.7 |   |
| Others, net of  reserves      |       | 367.9                |       | 41.7                 |       | 453.5                |       | 42.1 |   | 400.6 |   | 42.1 |   |
| Total                         |       | $                    | 882.0      |                 | 100.0      | %                    | $          | 1,075.4 |   | 100.0 | % | $ | 951.5 |   | 100.0 | % |

 
| **Sales by Type**          | ** ** | **2005  (restated)** | ** ** | **2004  (restated)** | ** ** | **2003  (restated)** | ** ** |
|--------------------------------------|------------|----------------------|------------|----------------------|------------|----------------------|------------|
| Hardware, net of  reserves           |       | $                    | 706.7      |                 | 80.1       | %                    | $          | 833.4 |   | 77.5 | % | $ | 689.9 |   | 72.5 | % |
| Software                             |       | 117.8                |       | 13.4                 |       | 155.7                |       | 14.5 |   | 154.5 |   | 16.2 |   |
| Resold  third-party service products |       | 37.2                 |       | 4.2                  |       | 66.6                 |       | 6.2 |   | 91.2 |   | 9.6 |   |
|  Services                       |       | 20.3                 |       | 2.3                  |       | 19.7                 |       | 1.8 |   | 15.9 |   | 1.7 |   |
| Total                                |       | $                    | 882.0      |                 | 100.0      | %                    | $          | 1,075.4 |   | 100.0 | % | $ | 951.5 |   | 100.0 | % |

 

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

*Sales*

Salesconsist of revenue from products delivered and services sold or rendered, netof allowances for customer returns and credits. Sales decreased $193.4 million,or 18.0%, from $1.1 billion in 2004 to $882.0 million in 2005.  The decrease in sales is due primarily to thedifficulties with the GEMS 

32

----

implementationduring second quarter of 2005 and a decrease in GTSI’s share of governmentspending overall. During the second quarter of 2005, due to the implementationproblems with GEMS, there were customer orders that could not be received intoGEMS and our ability to ship products was also negatively affected. As a resultof the problems with sales bookings, we experienced high turnover on salesteams. This caused reduced productivity throughout the third and fourthquarters, compounded by a workforce realignment in the fourth quarter thatfurther reduced sales team personnel. An analysis of sales by type reveals yearover year decreases for all types except services, most predominantly the$126.7 million decline in hardware sales to $706.7 million in 2005.

Althoughwe offer our customers access to products from hundreds of vendors,approximately 58% of our sales in 2005 were products from our top five vendors.As detailed in the preceding table, Panasonic remains our top vendor withproduct sales of $179.7 million in 2005. Network Appliance sales more than doubled from 2004 to $30.8 million tobecome one of our top five vendors for the first time in 2005. Our fifthlargest vendor during 2004 and 2003 was Microsoft. Sales of Microsoft productstotaled $27.0 million, $53.7 million, and $66.5 million during the years ended2005, 2004 and 2003, respectively. An increasing percentage of our total salesis derived from products from our top five vendors, reflecting our focusedvendor strategy implemented during 2005.

GTSI will be required to recertify our “smallbusiness” size status on our GSA Schedule Contract no later than 2007. At suchtime, we may not qualify as a small business. To mitigate any potential adverseaffect on our sales from the loss of our small business status, GTSI hasdeveloped strategic relationships with small businesses that benefit from thesmall business benefits described in the Business section in Part I of thisForm 10-K/A. GTSI acts as both a supplier and prime contractor to these smallbusinesses. In addition, we further mitigate this risk by participating in theMentor-Protégé Program offered under the SBAs 8(a) program, which is a businessdevelopment initiative that helps socially and economically disadvantagedAmericans gain access to economic opportunity.

*GrossMargin*

Grossmargin decreased $22.3 million, or 18.3%, from $122.1 million in 2004 to$99.8 million in 2005. Gross margin as a percentage of sales remainedconsistent at 11.3% in 2005 and 2004. In 2005, a $5.6 million charge for excessand obsolete inventory negatively impacted gross margin.  In addition, gross margin was positivelyaffected in 2005 and 2004 by $1.6 million and $2.5 million, respectively, forthe change in estimate of amounts payable to vendors.  In 2004, a $10.1 million non-cashextinguishment of aged vendor liabilities positively impacted gross margin.Gross margin excluding these adjustments was 11.7% in 2005 and 10.2% in 2004.

*Selling,General & Administrative Expenses*

Selling,general & administrative (“SG&A”) expenses for 2005 increased $9.4million, or 8.5% from 2004.  Thisincrease was predominantly related to compensation and benefits expense for newemployees as average headcount increased by 135 employees. In addition, on aper employee basis, average salaries increased approximately 7% year over year.Given the weak sales and margin performance during 2005, and the strains on theorganization associated with the GEMS implementations, we implemented twoseparate reductions in our workforce, one in October 2005 and one in February2006.  As a result of these activities,our workforce is now at comparable levels to where it had been in 2003 and thefirst half of 2004. SG&A expenses increased 3.1 percentage points as apercentage of sales from 2004 to 2005. These increases were partially offset bya $4.9 million decline in sales commissions corresponding to our decreased sales.

33

----

 

*Impairment Charge*

During2005 we 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 $1.0 million, net of accumulated amortization, in operatingexpenses to write down GEMS to its fair value as required by SFAS No. 144 *Accounting for the Impairment or Disposal of Long-Lived Assets*,(“FAS 144”).

*Interest and Other Income, Net*

Interestand other income, net decreased $1.3 million, or 25.7%, from 2004 to 2005. Thisdecrease was mainly due to increased interest expense from secured borrowings.In addition, interest expense increased from our Credit Facility borrowings dueto higher interest rates and increased borrowings as a result of workingcapital management issues.

*Income Taxes*

Werecorded a tax benefit of $3.2 million at an effective tax rate of 19.1% for2005 as compared to a tax provision of $6.9 million at an effective rate of40.4% for 2004. The decrease in our effective tax rate from 2004 to 2005 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$16.9 million.  As a result, our incometax benefit for 2005 solely consists of our tax refund that we will bereceiving as a result of carrying back our pre-tax loss to the amounts paid in2003 and 2004.

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

*Sales*

Salesincreased $123.9 million, or 13.0%, from $951.5 million in 2003 to $1.1 billionin 2004.  An analysis of sales by productreveals our overall sales increase was due to the $143.5 million rise inhardware to $833.4 million in 2004 generated by increased sales of networkingproducts, storage products and large server sales. This increase was partiallyoffset by a $24.6 million decline in sales of resold third-party serviceproducts. Sales of services increased 23.9% from 2003 to 2004 to $19.7 million.

Althoughwe offer our customers access to products from hundreds of vendors, 58.0% ofour sales in 2004 were products from our top five vendors. As detailed in thepreceding table, Panasonic remained our top vendor with product sales increasing$25.8 million from 2003 to 2004. Sales of Cisco and HP products also increased$22.8 million and $14.1 million, respectively, from the previous year. Theincrease in sales was also related to the $16.0 million decrease in backlog asof December 31, 2004 compared to 2003.

*GrossMargin*

Grossmargin increased $23.9 million, or 24.4%, from $98.2 million in 2003 to $122.1million in 2004. Gross margin as a percentage of sales increased from 10.3% for2003 to 11.4% in 2004. This increase was predominantly due to the reduction incost of sales resulting from the $10.1 million non-cash extinguishment of agedvendor liabilities.  Without the impactof this extinguishment, gross margin in 2004 would have been 10.4% as a percentageof sales.

*Selling,General & Administrative Expenses*

SG&Aexpenses for 2004 increased $20.8 million, or 23.3% from 2003.  This increase was primarily related toapproximately $8.0 million in compensation and benefits expense from increasedpersonnel and $6.1 million of additional commissions and commissionaccelerators on our increased sales. In addition, we incurred expenses of $2.0million in consulting fees for our Sarbanes-Oxley (“SOX”) compliance andapproximately $1.7 million for continued implementation of our ERP system.

34

----

* *

*Impairment Charge*

In the fourth quarter of 2003 we changed our strategyregarding GEMS from a highly customized enterprise resource planning (“ERP”)system to a standard ERP system because we determined that it was not in ourbest interest to continue to pursue a highly customized ERP solution due to thehigh level of development risk and the higher total cost of ownershipassociated with maintaining a customized solution. We decided to implement astandard ERP system that is expected to lower the risk, compress the deliverytime, provide significant value sooner, and reduce overall project expenses.Due to this change in strategy, we recorded an impairment charge of $6.0million for capitalized customization expenses determined to have no futureeconomic value.

*Interest and Other Income, Net*

Interestand other income, net increased $2.0 million, or 67.4%, from 2003 to 2004mainly due to the $2.9 million increase in lease-related income. This increasewas offset by the $0.7 million decrease in other income and the increase ininterest expense of $0.2 million.

*IncomeTaxes*

Werecorded a tax provision of $6.9 million for 2004, of which $3.9 million is dueto the reversal of aged accrued liabilities, based on our expected annualeffective tax rate of approximately 40.4%. For 2003 we recorded a tax provision of $2.6 million at an effectiverate of 43.9%. The decrease in our effective tax rate from 2003 to 2004 is dueto reduced state income taxes and a reduction in permanent non-deductible itemsas a percentage of earnings before taxes. The main difference between oureffective tax rate in 2004 and the statutory rate is state income taxes.

### **Seasonal Fluctuations**

We have historically experienced and expect to continue to experiencesignificant seasonal fluctuations in our operations as a result of the U.S.Federal Government buying and funding patterns. The unpredictability of thefactors affecting such seasonality makes our annual and quarterly financialresults difficult to predict and subject to significant fluctuation. Whilesales to the U.S. Federal Government are usually weaker in the first and secondquarter and stronger in the third and fourth quarter, our selling, general& administrative expenses are more level throughout the year. As such,first and second quarter earnings are typically well below those of the thirdand fourth quarters. Our stock price could be adversely affected if any suchfinancial results fail to meet the financial community’s expectations.

The following tables show our results of operations on a quarterlybasis (unaudited).  All quarters havebeen restated as described more completely in Note 3 to the consolidatedfinancial statements.  We believe thatthis information includes all adjustments necessary for a fair presentation ofsuch quarterly information when read in conjunction with the notes toconsolidated financial statements included in Item 8 of this Annual Report onForm 10-K/A.  The operating results forany quarter are not necessarily indicative of the results for any future period.  This information has been included to provideadditional insight into the seasonal nature of our business.

The restatements include prior period adjustments for: i) the transferof certain receivables to third parties, ii) overstatement of accounts payableand the related cost of sales, and iii) the recording of miscellaneousaccounting adjustments appropriate for the fair presentation of the financialstatements.

35

----

 
| ** **                                                       | ** ** | **2005**           | ** ** |
|------------------------------------------------------------------|------------|--------------------|------------|
| **(in millions except per share data)** | ** ** | **Q1  (restated)** | ** ** | **Q2  (restated)** | ** ** | **Q3  (restated)** | ** ** | **Q4  (restated)** | ** ** | **Total  (restated)** | ** ** |
| Sales                                                            |       | $                  | 156.6      |   | $ | 179.1 |   | $ | 267.4 |   | $ | 278.9 |   | $ | 882.0 |   |
| Cost of sales                                                    |       | 139.2              |       | 160.1 |   | 231.5 |   | 251.4 |   | 782.2 |   |
| Gross margin                                                     |       | 17.4               |       | 19.0 |   | 35.9 |   | 27.5 |   | 99.8 |   |
| Operating  expenses                                              |       | 28.1               |       | 28.4 |   | 31.9 |   | 31.9 |   | 120.3 |   |
| (Loss) income  from operations                                   |       | (10.7              | )          | (9.4 | ) | 4.0 |   | (4.4 | ) | (20.5 | ) |
| Interest and  other income, net                                  |       | 0.7                |       | 0.5 |   | 0.7 |   | 1.7 |   | 3.6 |   |
| (Loss) income  before taxes                                      |       | (10.0              | )          | (8.9 | ) | 4.7 |   | (2.7 | ) | (16.9 | ) |
| Income tax  benefit (provision)                                  |       | 3.8                |       | 3.4 |   | (1.7 | ) | (2.3 | ) | 3.2 |   |
| Net (loss) income                                                |       | $                  | (6.2       | ) | $ | (5.5 | ) | $ | 3.0 |   | $ | (5.0 | ) | $ | (13.7 | ) |
|                                                             |       |               |       |   |   |   |   |   |   |   |   |
| Basic (loss)  earnings per share                                 |       | $                  | (0.69      | ) | $ | (0.60 | ) | $ | 0.32 |   | $ | (0.53 | ) | $ | (1.49 | ) |
| Diluted (loss) earnings  per share                               |       | $                  | (0.69      | ) | $ | (0.60 | ) | $ | 0.31 |   | $ | (0.53 | ) | $ | (1.49 | ) |

 
| ** **                                                       | ** ** | **2004**           | ** ** |
|------------------------------------------------------------------|------------|--------------------|------------|
| **(in millions except per share data)** | ** ** | **Q1  (restated)** | ** ** | **Q2  (restated)** | ** ** | **Q3  (restated)** | ** ** | **Q4  (restated)** | ** ** | **Total  (restated)** | ** ** |
| Sales                                                            |       | $                  | 177.8      |   | $ | 240.2 |   | $ | 322.9 |   | $ | 334.5 |   | $ | 1,075.4 |   |
| Cost of sales                                                    |       | 159.4              |       | 218.7 |   | 276.7 |   | 298.5 |   | 953.3 |   |
| Gross margin                                                     |       | 18.4               |       | 21.5 |   | 46.2 |   | 36.0 |   | 122.1 |   |
| SG&A  expenses                                               |       | 21.7               |       | 24.6 |   | 30.3 |   | 33.4 |   | 110.0 |   |
| (Loss) income  from operations                                   |       | (3.3               | )          | (3.1 | ) | 15.9 |   | 2.6 |   | 12.1 |   |
| Interest and  other income, net                                  |       | 0.5                |       | 0.7 |   | 1.3 |   | 2.4 |   | 4.9 |   |
| (Loss) income  before taxes                                      |       | (2.8               | )          | (2.4 | ) | 17.2 |   | 5.0 |   | 17.0 |   |
| Income tax  benefit (provision)                                  |       | 1.2                |       | 1.0 |   | (7.1 | ) | (2.0 | ) | (6.9 | ) |
| Net (loss)  income                                               |       | $                  | (1.6       | ) | $ | (1.4 | ) | $ | 10.1 |   | $ | 3.0 |   | $ | 10.1 |   |
|                                                             |       |               |       |   |   |   |   |   |   |   |   |
| Basic (loss)  earnings per share                                 |       | $                  | (0.19      | ) | $ | (0.17 | ) | $ | 1.17 |   | $ | 0.35 |   | $ | 1.17 |   |
| Diluted (loss) earnings  per share                               |       | $                  | (0.19      | ) | $ | (0.17 | ) | $ | 1.10 |   | $ | 0.33 |   | $ | 1.05 |   |

 

TheCompany’s tax benefit (provision) was determined on a quarterly basis for theyears ended December 31, 2005 and 2004 using the overall annual effective ratepursuant to APB No. 28, *Interim FinancialReporting*. GTSI’s income tax benefit in 2005 is solely due to thetax loss carryforward realized by the Company.

**Liquidity and CapitalResources**

*Cash flows for the year ended December 31,*

| (in millions)                     | ** ** | **2005  (restated)** | ** ** | **2004  (restated)** | ** ** | **Increase/  (Decrease)** | ** ** |
|----------------------------------------|------------|----------------------|------------|----------------------|------------|---------------------------|------------|
| Cash used in  operating activities     |       | $                    | (109.5     | )                    | $          | (2.5                      | )          | $ | (107.0 | ) |
| Cash used in  investing activities     |       | $                    | (3.7       | )                    | $          | (7.5                      | )          | $ | 3.8 |   |
| Cash provided by  financing activities |       | $                    | 112.8      |                 | $          | 10.2                      |       | $ | 102.6 |   |

 

Cashused in operating activities for the year ended December 31, 2005 was $109.5million, an increase of $(107.0) million from 2004.  This increase was primarily due to our netloss of $13.7 million and the increase in our financed receivables and paymentsof trade payables.

36

----

During2005 we experienced 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 in the correspondingcash receipts from our customers.

Cashused in investing activities in 2005 was $3.8 million less than cash used in2004, and consisted principally of investments in GEMS during the early portionof the year.  A much larger investment inGEMS occurred during 2004.

Cashprovided by financing activities of $112.8 million during 2005 was dueprincipally to proceeds from financed lease debt of $67.1 million andborrowings of $19.3 million under our revolving Credit Facility.  The number of customer transactions utilizinglease arrangements increased significantly between 2004 and 2005. Because it isour business model to finance most of our lease receivables we saw acorresponding increase in proceeds from financed receivables.  The proceeds from the transfer of receivablesto third party financial institutions increased $47.8 million in 2005, morethan tripling from 2004. We plan to continue to increase the percentage oftransactions with our customers under lease arrangements; therefore, we expectour cash provided by financing activities to continue to increase.Additionally, proceeds of $3.8 million from the exercise of employee stockoptions and employee stock purchase plan activity were offset by borrowings of$4.9 million to purchase GTSI’s common stock.

*CreditFacility*

Asof December 31, 2005 we had a $135 million revolving Credit Facility with agroup of banks that expires on May 31, 2006. The Credit Facility includes arevolving line of credit (the “Revolver”) and a provision for inventoryfinancing of vendor products (the “Wholesale Financing Facility”). Borrowingunder the Revolver is limited to 85% of eligible accounts receivable.  The Revolver is secured by substantially allof our assets. Borrowing under the Wholesale Financing Facility is limited to100% of the value of our inventory and was $29.5 million as of December 31,2005.  The Wholesale Financing Facilityis secured by the underlying inventory.  The Credit Facility carried an interest rateindexed to the London Interbank Offered Rate (“LIBOR”) plus 1.75 percentagepoints as of December 31, 2005.  TheCredit Facility also contains certain covenants as well as provisionsspecifying compliance with certain quarterly and annual financial ratios.

Duringthe year ended December 31, 2005, we signed four amendments to the CreditFacility to change the size of the facility, add additional lenders to thesyndicate, change certain debt covenants, and extend the expiration date.During the year ended December 31, 2004, we and our lenders signed threeamendments to the Credit Facility to add a new lender and add our wholly ownedsubsidiaries, TLI and GTSI Financial Services, as borrowers.

Asof December 31, 2005 and 2004, our interest rate under the Credit Facility was6.1% and 4.2%, respectively.  Theweighted average interest rates for the years ended December 31, 2005, 2004 and2003 were 5.1%, 3.2% and 3.0%, respectively.

Wewere in compliance with all financial covenants set forth in the CreditFacility as of December 31, 2005. However, as of January 31, 2006 GTSIdefaulted on the following financial covenants under the Credit Facility: (i)maximum funded indebtedness to EBITDA, (ii) minimum EBIT to net sales, and (iii)minimum tangible net worth. Our lenders requested the execution of an agreementto temporarily forbear them from enforcing their rights and remedies as aresult of the events of default. Subsequent to December 31, 2005, a forbearanceagreement (the “Credit Agreement”) was executed between GTSI and our lenders.See Note 16 for additional details and disclosure related to the CreditAgreement.  On April 3, 2006, wedefaulted on a covenant under the Credit Agreement when we received a staffdetermination letter from the NASDAQ National Market stating that because wehad not filed our Annual Report on Form 10-K for 2005 with the SEC, as requiredby Market Place Rule 4310(c)(14), GTSI’s common stock is subject to delistingfrom the NASDAQ National Market.  We haverequested a hearing with NASDAQ 

37

----

whichshould stay the delisting pending the determination of NASDAQ’s hearingpanel.  While there is no assurance, weexpect to avoid delisting of our common stock from the NASDAQ National Marketby the filing of this Form 10-K.  TheCompany had available credit of $41.2 million as of December 31, 2005 and $59.0million as of December 31, 2004.

*CapitalResources and Requirements*

Ourongoing capital requirements depend on a variety of factors, including theextent to which we are able to fund the cash needs of our business fromoperations.  During 2005, we experiencedsignificant working capital shortages as a result of our operational problemsand lower sales volumes, and relied upon vendor credit and borrowings under ourCredit Facility to fund our operations. We anticipate that we will continue to rely primarily on vendor creditand a replacement credit facility to finance our operating cash needs duringthe majority of 2006.  We believe thatsuch funds should be sufficient to satisfy our near term anticipated cashrequirements for operations, assuming we are successful at structuring a newrevolving credit facility prior to the expiration of our existing CreditFacility on May 31, 2006.  We continue tohave discussions with lenders related to structuring a new revolving creditfacility and on April 10, 2006 we signed a commitment letter to negotiate a newrevolving credit facility with two major money center banks by May 31, 2006,the expiration date of the current Credit Facility.  Nonetheless, we may seek additional sources ofcapital, including obtaining permanent financing over a longer term at fixedrates, to finance our working capital requirements or other strategicinitiatives.  If we are unable to obtainalternative financing it would likely have a material adverse affect on ourfinancial condition and ability to continue as a going concern.

Financedlease debt increased from $17.9 million at December 31, 2004 to $41.2 millionat December 31, 2005, bearing weighted average interest rates of 6.83% and5.89%, respectively. These secured borrowings will be funded from the financingreceivables of $23.8 million and $41.6 million as of December 31, 2004 and2005, respectively.

During2005 and 2004, we made capital expenditures of $3.7 million and $7.5 million,respectively, principally for capitalized costs associated with theimplementation of GEMS and the purchase of computer software for internal use.

**ContractualObligations**
| **(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      |       | —                          |       | —         |       |
| Financed lease  debt              |       | 41.2       |       | 25.2      |       | 16.0                            |       | —         |       |
| Total Contractual  Obligations    |       | $          | 100.6      |      | $          | 76.1                            |       | $              | 22.9       |           | $          | 1.6 |   |

 

Asof December 31, 2005, we had an employment agreement with our former ChiefExecutive Officer and change in control agreements with an additional 15executives and key employees which contingently obligate us to make payments of$4.1 million if the CEO is terminated or if key employees are terminatedrelated to a change in control of GTSI.

Asof December 31, 2005 GTSI was obligated under an operating lease to provide ourlandlord with a letter of credit in the amount of $0.2 million as a securitydeposit for all tenant improvements associated with the lease.  We were also obligated to provide a letter ofcredit in the amount of $1.75 million to guarantee our performance of allobligations under a customer contract. This letter of credit expired onFebruary 28, 2006.

38

----

**Off-BalanceSheet Arrangements**

Wehave no off-balance sheet arrangements (as defined in Regulations S-K, Item303, paragraph (a)(4)(ii)) that have or are reasonably likely to have amaterial current or future effect on its financial condition, changes infinancial condition, sales or expenses, results of operations, liquidity,capital expenditures or capital resources.

**NewAccounting Pronouncements**

InDecember 2004, the Financial Accounting Standards Board issued Statement ofFinancial Accounting Standards (“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 our current accounting under APB 25. InApril 2005, the SEC adopted a new rule that amends the compliance date for FAS123R to be effective as of the beginning of the first annual reporting periodthat begins after June 15, 2005. Thus, we adopted the standard as of January 1,2006 using the modified prospective transition method. We considered theimplementation guidance for FAS 123R issued by the SEC in Staff AccountingBulletin No. 107 in the adoption of FAS 123R.

Accordingly,the adoption of FAS 123R’s fair value method will have a significant impact onour results of operations. The impact to net income for the year ended December31, 2005 cannot be predicted at this time because it will depend on levels ofshare-based payments granted in the future. However, based on the unvested stockoptions that were outstanding as of December 31, 2005 we expect to record stockcompensation of approximately $900 thousand during 2006 as a result of adoptingFAS123R.  FAS123R also requires thebenefits of tax deductions in excess of recognized compensation cost to bereported as a financing cash flow, rather than as an operating cash flow asrequired under current literature. This requirement will reduce net operatingcash flows and increase net financing cash flows in periods after adoption.

InJune 2005, the FASB issued SFAS No. 154, *Accounting Changes andError Corrections*, (“FAS 154”) which is a replacement of APB OpinionNo. 20, *Accounting Changes* and SFAS No. 3, *Reporting Accounting Changes in Interim Financial Statements*.FAS 154 changes the accounting for and reporting of changes in accountingprinciples and error corrections by requiring retrospective application toprior period financial statements unless impracticable. This statement iseffective in fiscal years beginning after December 15, 2005. We do not expectthe adoption of FAS 154 to have a significant impact on our consolidatedfinancial statements.

39

----

**ITEM 7A.               QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKETRISK**

GTSI had a $135 millionCredit Facility indexed at LIBOR plus 1.75 percentage points as of December 31,2005. This Credit Facility exposes us to market risk from changes in interestrates. For purposes of specific risk analysis, we use sensitivity analysis todetermine the effects that market risk exposures may have.

Our results of operationsare affected by changes in interest rates due to the impact those changes haveon borrowings under our Credit Facility. If interest rates increase, our debtservice obligations on the variable rate indebtedness would increase even thoughthe amount borrowed remained the same, which would require more cash to serviceour indebtedness. As of December 31, 2005, the effect of a 5% increase ininterest rates would have resulted in additional interest expense during 2005of $0.7 million based on our average monthly balances. We have not usedderivative instruments to alter the interest rate characteristics of ourborrowings. As of December 31, 2005 we had $55.8 million of variable rate debtsubject to interest.

Included in our long-termdebt are amounts related to lease transactions. We have reported these amounts in Note 6 as long-term financedlease debt.  These amounts will amortizeover the period of the lease instruments with no cash affect to theCompany.  The balances of theseliabilities were $16.0 million and $9.3 million at December 31, 2005 and 2004,respectively. A change in interest rates would result in no additional interestexpense related to financed lease debt.

 

40

----

 

**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 balance sheets of GTSICorp. as of December 31, 2005 and 2004, and the related consolidated statementsof operations, changes in stockholders’ equity, and cash flows for each of thethree years in the period ended December 31, 2005. Our audit also included thefinancial statement schedule listed in the Index at Item 15(a). These financialstatements and schedule are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements and thefinancial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above presentfairly, in all material respects, the consolidated financial position of GTSICorp. as of December 31, 2005 and 2004, and the consolidated results of itsoperations and its cash flows for each of the three years in the period endedDecember 31, 2005, in conformity with U.S. generally accepted accountingprinciples. Also, in our opinion, the related financial statement schedule,when considered in relation to the basic financial statements taken as a whole,presents fairly in all material respects the information set forth therein.

As discussed in Note 3 to the consolidated financial statements, theaccompanying consolidated balance sheets as of December 31, 2005 and 2004 andthe related consolidated statements of operations, changes in stockholders’equity and cash flows for each of the three years in the period ended December31, 2005 have been restated.

The accompanying financial statements have been prepared assuming thatGTSI Corp. will continue as a going concern. As more fully described in Note 2, the Company incurred a net loss of$13.7 million and used $109.5 million of cash in operating activities duringthe year ended December 31, 2005 and had not complied with certain covenants ofbank loan agreements as of January 31, 2006. In addition, the Company’s currentlending agreement expires on May 31, 2006. These conditions raise substantialdoubt about the Company’s ability to continue as a going concern. Management’splans in regard to these matters are also described in Note 2. The financialstatements do not include any adjustments to reflect the possible future effectson the recoverability and classification of assets or the amounts andclassification of liabilities that may result from the outcome of thisuncertainty.

We also have audited, in accordance with the standards of the PublicCompany Accounting Oversight Board (United States), the effectiveness of GTSICorp.’s internal control over financial reporting as of December 31, 2005,based on criteria established in Internal Control—Integrated Framework issuedby the Committee of Sponsoring Organizations of the Treadway Commission and ourreport dated April 10, 2006 (except for the effects of the material weaknessesdescribed in the eighth and ninth paragraphs of that report, as

41

----

 

to which the date is December 21, 2006) expressed an unqualifiedopinion on management’s assessment and an adverse opinion on the effectivenessof the Company’s internal control over financial reporting because of theexistence of certain material weaknesses.

/S/ ERNST & YOUNG LLP

McLean, Virginia

April 10, 2006 (except for Notes 3, 5 and 6, as towhich the date is December 21, 2006)

 

42

----

**FINANCIALSTATEMENT AND SUPPLEMENTARY DATA**GTSI CORP.CONSOLIDATED BALANCE SHEETS(In thousands, except share and per share data)
| ** **                                                                                                                                                                                                             | ** ** | **December 31,**                        | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                                                                                                                                             | ** ** | **2005**(restated see Note 3) | ** ** | **2004**(restated see Note 3) | ** ** |
| **ASSETS**                                                                                                                                                                                                             | ** ** | ** **                                   | ** ** | ** ** | ** ** |
| Current assets:                                                                                                                                                                                                        | ** ** | ** **                                   | ** ** | ** ** | ** ** |
| Cash                                                                                                                                                                                                                   |       | $                                            | 27         |   | $ | 387 |   |
| Accounts  receivable, net                                                                                                                                                                                              |       | 226,356                                      |       | 217,132 |   |
| Inventory                                                                                                                                                                                                              |       | 56,819                                       |       | 59,070 |   |
| Deferred costs                                                                                                                                                                                                         |       | 17,069                                       |       | 4,934 |   |
| Other current  assets                                                                                                                                                                                                  |       | 8,605                                        |       | 5,885 |   |
| Total current  assets                                                                                                                                                                                                  |       | 308,876                                      |       | 287,408 |   |
| Depreciable  assets, net                                                                                                                                                                                               |       | 13,640                                       |       | 15,183 |   |
| Long-term  financing receivables and other assets                                                                                                                                                                      |       | 23,391                                       |       | 11,317 |   |
| Total assets                                                                                                                                                                                                           |       | $                                            | 345,907    |   | $ | 313,908 |   |
|                                                                                                                                                                                                                   |       |                                         |       |   |   |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                                                                         |       |                                         |       |   |   |
| Current liabilities:                                                                                                                                                                                                   |       |                                         |       |   |   |
| Borrowings under  credit facility                                                                                                                                                                                      |       | $                                            | 48,014     |   | $ | 1,168 |   |
| Accounts payable                                                                                                                                                                                                       |       | 151,995                                      |       | 171,809 |   |
| Financed lease  debt                                                                                                                                                                                                   |       | 25,187                                       |       | 8,645 |   |
| Accrued  liabilities                                                                                                                                                                                                   |       | 16,603                                       |       | 14,856 |   |
| Deferred revenue                                                                                                                                                                                                       |       | 6,020                                        |       | 9,487 |   |
| Accrued warranty  liabilities                                                                                                                                                                                          |       | 849                                          |       | 2,429 |   |
| Total current  liabilities                                                                                                                                                                                             |       | 248,668                                      |       | 208,394 |   |
| Long-term  financed lease debt                                                                                                                                                                                         |       | 15,996                                       |       | 9,273 |   |
| Other  liabilities                                                                                                                                                                                                     |       | 3,076                                        |       | 3,826 |   |
| Total  liabilities                                                                                                                                                                                                     |       | 267,740                                      |       | 221,493 |   |
|                                                                                                                                                                                                                   |       |                                         |       |   |   |
| Commitments and  contingencies — See Note 14                                                                                                                                                                      |       |                                         |       |   |   |
|                                                                                                                                                                                                                   |       |                                         |       |   |   |
| 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  9,307,606 outstanding as of December 31, 2005; and 9,806,084 issued and 8,987,643  outstanding as of December 31, 2004 |       | 49                                           |       | 49 |   |
| Capital in  excess of par value                                                                                                                                                                                        |       | 45,104                                       |       | 47,047 |   |
| Retained  earnings                                                                                                                                                                                                     |       | 36,731                                       |       | 50,404 |   |
| Treasury stock,  498,478 shares as of December 31, 2005 and 818,441 shares as of December 31,  2004, at cost                                                                                                 |       | (3,717                                       | )          | (5,085 | ) |
| Total  stockholders’ equity                                                                                                                                                                                       |       | 78,167                                       |       | 92,415 |   |
| Total liabilities and  stockholders’ equity                                                                                                                                                                       |       | $                                            | 345,907    |   | $ | 313,908 |   |

 

The accompanying notes are an integral part of theseconsolidated financial statements.

43

----

**GTSI CORP.CONSOLIDATED STATEMENTS OF OPERATIONS**(In thousands, except per share data)
| ** **                                      | ** ** | **For the Years Ended December 31,** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                      | ** ** | **2005**(restated  see Note 3)                      | ** ** | **2004**(restated  see Note 3) | ** ** | **2003**(restated  see Note 3) | ** ** |
|                                            |       |                                                          |       |   |   |   |   |
| SALES                                           |       | $                                                             | 882,012    |   | $ | 1,075,437 |   | $ | 951,511 |   |
|                                            |       |                                                          |       |   |   |   |   |
| COST OF SALES                                   |       | 782,210                                                       |       | 953,345 |   | 853,354 |   |
|                                            |       |                                                          |       |   |   |   |   |
| GROSS MARGIN                                    |       | 99,802                                                        |       | 122,092 |   | 98,157 |   |
|                                            |       |                                                          |       |   |   |   |   |
| SELLING, GENERAL &  ADMINISTRATIVE EXPENSES |       | 119,371                                                       |       | 110,015 |   | 89,206 |   |
|                                            |       |                                                          |       |   |   |   |   |
| IMPAIRMENT CHARGE                               |       | 981                                                           |       | - |   | 5,972 |   |
| TOTAL OPERATING  EXPENSES                       |       | 120,352                                                       |       | 110,015 |   | 95,178 |   |
|                                            |       |                                                          |       |   |   |   |   |
| (LOSS) INCOME FROM  OPERATIONS                  |       | (20,550                                                       | )          | 12,077 |   | 2,979 |   |
|                                            |       |                                                          |       |   |   |   |   |
| INTEREST AND OTHER  INCOME                      |       |                                                          |       |   |   |   |   |
| Lease-related  income                           |       | 4,573                                                         |       | 3,786 |   | 926 |   |
| Interest and  other income                      |       | 1,778                                                         |       | 2,135 |   | 2,793 |   |
| Interest expense                                |       | (2,700                                                        | )          | (1,005 | ) | (782 | ) |
| Interest and  other income, net                 |       | 3,651                                                         |       | 4,916 |   | 2,937 |   |
|                                            |       |                                                          |       |   |   |   |   |
| (LOSS) INCOME BEFORE  INCOME TAXES              |       | (16,899                                                       | )          | 16,993 |   | 5,916 |   |
|                                            |       |                                                          |       |   |   |   |   |
| INCOME TAX BENEFIT  (PROVISION)                 |       | 3,226                                                         |       | (6,858 | ) | (2,598 | ) |
|                                            |       |                                                          |       |   |   |   |   |
| NET (LOSS) INCOME                               |       | $                                                             | (13,673    | ) | $ | 10,135 |   | $ | 3,318 |   |
|                                            |       |                                                          |       |   |   |   |   |
|                                            |       |                                                          |       |   |   |   |   |
| (LOSS) EARNINGS PER  SHARE                      |       |                                                          |       |   |   |   |   |
| Basic                                           |       | $                                                             | (1.49      | ) | $ | 1.17 |   | $ | 0.40 |   |
| Diluted                                         |       | $                                                             | (1.49      | ) | $ | 1.05 |   | $ | 0.36 |   |
|                                            |       |                                                          |       |   |   |   |   |
| WEIGHTED AVERAGE COMMON  SHARES OUTSTANDING     |       |                                                          |       |   |   |   |   |
| Basic                                           |       | 9,166                                                         |       | 8,664 |   | 8,343 |   |
| Diluted                                         |       | 9,166                                                         |       | 9,618 |   | 9,308 |   |

 

The accompanying notes are an integral part of theseconsolidated financial statements.

44

----

 

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

 
| ** **                              | ** ** | **Common Stock**                                     | ** ** | **Capital in**                          | ** ** | ** **                                                           | ** ** | ** **                                               | ** ** | **Total**                                             | ** ** |
|-----------------------------------------|------------|-----------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------------------------------|------------|----------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                              | ** ** | **Shares  Outstanding  (restated  see Note 3)** | ** ** | **Amount  (restated  see Note 3)** | ** ** | **Excess of  Par Value  (restated  see Note 3)** | ** ** | **Retained  Earnings  (restated  see Note 3)** | ** ** | **Treasury  Stock  (restated  see Note 3)** | ** ** | **Stockholders’  Equity  (restated  see Note 3)** | ** ** |
| **Balance, December 31, 2002**          |       | 8,603                                                     |       | $                                            | 49         |                                                                 | $          | 44,439                                                   |       | $                                                     | 36,951     |   | $ | (5,948 | ) | $ | 75,491 |   |
| Stock options exercised                 |       | 355                                                       |       | —                                       |       | (152                                                                 | )          | —                                                   |       | 2,000                                                 |       | 1,848 |   |
| Employee stock purchase  plan           |       | 147                                                       |       | —                                       |       | 448                                                                  |       | —                                                   |       | 885                                                   |       | 1,333 |   |
| Common stock purchase                   |       | (600                                                      | )          | —                                       |       | —                                                               |       | —                                                   |       | (5,020                                                | )          | (5,020 | ) |
| Stock based  compensation               |       | —                                                    |       | —                                       |       | 268                                                                  |       | —                                                   |       | —                                                |       | 268 |   |
| Tax benefit of stock  options exercised |       | —                                                    |       | —                                       |       | 1,114                                                                |       | —                                                   |       | —                                                |       | 1,114 |   |
| Net income                              |       | —                                                    |       | —                                       |       | —                                                               |       | 3,318                                                    |       | —                                                |       | 3,318 |   |
| **Balance, December 31, 2003**          |       | 8,505                                                     |       | 49                                           |       | 46,117                                                               |       | 40,269                                                   |       | (8,083                                                | )          | 78,352 |   |
| Stock options exercised                 |       | 398                                                       |       | —                                       |       | (694                                                                 | )          | —                                                   |       | 2,470                                                 |       | 1,776 |   |
| Employee stock purchase  plan           |       | 85                                                        |       | —                                       |       | 267                                                                  |       | —                                                   |       | 528                                                   |       | 795 |   |
| Stock based  compensation               |       | —                                                    |       | —                                       |       | 480                                                                  |       | —                                                   |       | —                                                |       | 480 |   |
| Tax benefit of stock  options exercised |       | —                                                    |       | —                                       |       | 877                                                                  |       | —                                                   |       | —                                                |       | 877 |   |
| Net income                              |       | —                                                    |       | —                                       |       | —                                                               |       | 10,135                                                   |       | —                                                |       | 10,135 |   |
| **Balance, December 31, 2004**          |       | 8,988                                                     |       | 49                                           |       | 47,047                                                               |       | 50,404                                                   |       | (5,085                                                | )          | 92,415 |   |
| Stock options exercised                 |       | 803                                                       |       | —                                       |       | (2,065                                                               | )          | —                                                   |       | 5,346                                                 |       | 3,281 |   |
| Employee stock purchase  plan           |       | 77                                                        |       | —                                       |       | (60                                                                  | )          | —                                                   |       | 554                                                   |       | 494 |   |
| Common stock purchase                   |       | (610                                                      | )          | —                                       |       | —                                                               |       | —                                                   |       | (4,874                                                | )          | (4,874 | ) |
| Stock based  compensation               |       | —                                                    |       | —                                       |       | 33                                                                   |       | —                                                   |       | —                                                |       | 33 |   |
| Restricted stock issued                 |       | 50                                                        |       | —                                       |       | (189                                                                 | )          | —                                                   |       | 342                                                   |       | 153 |   |
| Tax benefit of stock  options exercised |       | —                                                    |       | —                                       |       | 338                                                                  |       | —                                                   |       | —                                                |       | 338 |   |
| Net loss                                |       | —                                                    |       | —                                       |       | —                                                               |       | (13,673                                                  | )          | —                                                |       | (13,673 | ) |
| **Balance, December 31, 2005**          |       | 9,308                                                     |       | $                                            | 49         |                                                                 | $          | 45,104                                                   |       | $                                                     | 36,731     |   | $ | (3,717 | ) | $ | 78,167 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

45

----

 

**GTSICORP.CONSOLIDATED STATEMENTS OF CASH FLOWS**(In thousands)
| ** **                                                                            | ** ** | **For the Years Ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                            | ** ** | **2005  (restated  see Note 3)**                    | ** ** | **2004  (restated  see Note 3)** | ** ** | **2003  (restated  see Note 3)** | ** ** |
| **CASH FLOWS FROM OPERATING  ACTIVITIES:**                                            |       |                                                          |       |   |   |   |   |
| Net (loss) income                                                                     |       | $                                                             | (13,673    | ) | $ | 10,135 |   | $ | 3,318 |   |
| Adjustments to  reconcile net (loss) income to net cash used in 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                                                             |       | 186                                                           |       | 480 |   | — |   |
| Deferred tax  provision (benefit)                                                     |       | (441                                                          | )          | 4,415 |   | (378 | ) |
| Tax benefit of  stock options exercised                                               |       | 338                                                           |       | 877 |   | 1,114 |   |
| Reversal of  vendor payables                                                          |       | —                                                        |       | (10,120 | ) | — |   |
| Changes in  operating assets and liabilities:                                         |       |                                                          |       |   |   |   |   |
| Accounts  receivable                                                                  |       | (53,047                                                       | )          | (39,797 | ) | (48,097 | ) |
| Inventory                                                                             |       | 2,250                                                         |       | (3,083 | ) | 52 |   |
| Other current  assets                                                                 |       | (15,001                                                       | )          | 1,146 |   | (2,713 | ) |
| Other assets                                                                          |       | (12,074                                                       | )          | (3,333 | ) | (5,396 | ) |
| Accounts payable                                                                      |       | (19,813                                                       | )          | 29,051 |   | 30,445 |   |
| Other liabilities                                                                     |       | (3,463                                                        | )          | 4,703 |   | 8,230 |   |
| Net cash used in  operating activities                                                |       | (109,507                                                      | )          | (2,504 | ) | (4,515 | ) |
|                                                                                  |       |                                                          |       |   |   |   |   |
| **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                                       |       | 46,846                                                        |       | (11,645 | ) | 5,274 |   |
| Proceeds from financed  lease debt                                                    |       | 67,089                                                        |       | 19,323 |   | 8,830 |   |
| Common stock purchases                                                                |       | (4,874                                                        | )          | — |   | (5,020 | ) |
| Proceeds from employee  stock purchase plan                                           |       | 494                                                           |       | 795 |   | 1,333 |   |
| Proceeds from exercises  of stock options                                             |       | 3,280                                                         |       | 1,776 |   | 2,116 |   |
| Net cash provided by  financing activities                                            |       | 112,835                                                       |       | 10,249 |   | 12,533 |   |
|                                                                                  |       |                                                          |       |   |   |   |   |
| NET (DECREASE) INCREASE  IN CASH                                                      |       | (360                                                          | )          | 210 |   | 145 |   |
| CASH AT BEGINNING OF  YEAR                                                            |       | 387                                                           |       | 177 |   | 32 |   |
| CASH AT END OF YEAR                                                                   |       | $                                                             | 27         |   | $ | 387 |   | $ | 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 theseconsolidated financial statements.

46

----

 

**GTSI CORP.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**For the Years Ended December 31, 2005, 2004 and 2003**

**1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

**A.  Nature of Operations**

GTSICorp. (collectively with its subsidiaries, “GTSI” or the “Company”) is an ITsolutions provider, focusing predominantly on U.S. Federal, state, and localgovernment customers. GTSI solves government technology challenges withindustry-leading solutions, a powerful collection of contracts, dedicated teamsof certified experts, flexible financing options, and ISO 9001:2000 registeredglobal integration and distribution.

GTSIuses its technical experts to assess, design, implement and maintain complexsolutions and deliver services relating to networking, enterprise computing, wireless,IT security, physical security, storage, and software. Additionally, GTSImarkets and sells products, primarily computer hardware and software, throughits web site, gtsi.com, providing convenient, customized shopping zones to meetthe unique and changing needs of its customers.

Formore than 20 years, the Company has combined its understanding of Federal,state and local government technology needs with long-standing relationshipswith global IT leaders like Panasonic, HP, Cisco, Sun Microsystems, andMicrosoft.

GTSI’sprimary business is conducted from its headquarters and distribution centerlocated in Chantilly, Virginia, outside of Washington D.C., and has officesthroughout the United States.

**B.  Principles of Consolidation**

Theconsolidated financial statements include the accounts of GTSI and itswholly-owned subsidiaries. All intercompany accounts and transactions have beeneliminated.  Investments in which theCompany 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. and TechnologyLogistics, Inc. (“TLI”).

**C.  Revenue Recognition**

GTSIrecognizes revenue when persuasive evidence of a sale arrangement exists,delivery has occurred or services have been rendered, the sales price is fixedor determinable, and collectibility is reasonably assured in accordance withSEC Staff Accounting Bulletin No. 104, *Revenue Recognition inFinancial Statements* (“SAB 104”).

Whena customer order contains multiple items such as hardware, software, andservices which are delivered at varying times, the Company determines whetherthe delivered items can be considered separate units of accounting asprescribed under Emerging Issues Task Force (“EITF”) Issue No. 00-21, *Revenue Arrangements with Multiple Deliverables* (“EITF 00-21”).EITF 00-21 states that delivered

47

----

 

itemsshould be considered separate units of accounting if delivered items have valueto the customer on a standalone basis, there is objective and reliable evidenceof the fair value of undelivered items, and if delivery of undelivered items isprobable and substantially in GTSI’s control.

Generally,the Company is able to establish fair value for all elements of the arrangement.In these instances, revenue is recognized on each element separately. However,if fair value cannot be established or if the delivered items do not have standalone value to the customer without additional services provided, the Companyrecognizes revenue on the contract as a whole based on either the completed-contractor proportional-performance methods as described below.

Inmost cases, revenue from hardware and software product sales is recognized whentitle passes to the customer. Based upon the Company’s standard shipping terms,FOB destination, title passes upon delivery of the products to the customer.However, occasionally GTSI’s customers will request bill-and-hold transactionsin situations where the customer does not have space available to receiveproducts or for another business purpose, in which case GTSI will store thepurchased equipment in its distribution center. Under SAB 104, the Company onlyrecognizes revenue for bill-and-hold transactions when the goods are completeand ready for shipment, title and risk of loss have passed to the customer,management receives a written request from the customer for bill-and-holdtreatment, and the ordered goods are physically segregated in GTSI’s warehousefrom other inventory and cannot be used to fulfill other customer orders.

Revenueis recognized on service contracts using either the completed-contract orproportional-performance method depending on the terms of the serviceagreement.  When the amount of servicesto be performed 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-contract method is used.Once the last significant act has been performed, revenue is recognized. TheCompany 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.

Inmany contracts, billing terms are agreed upon based on performance milestonessuch as the execution of a contract, the customer’s acceptance of the equipmentand/or vendor for products, the partial or complete delivery of products and/orthe completion of specified services. Payments received before delivery hasoccurred or services have been rendered are recorded as deferred revenue untilthe revenue recognition criteria are met. Deferred revenue from extendedwarranty contracts is recognized over the terms of the extended warranty.

TheCompany sells products to certain customers under sales-type lease arrangementsfor terms typically ranging from two to four years.  The Company accounts for its sales-typeleases according to the provisions of Statement of Financial AccountingStandards (“FAS”) No. 13 *Accounting for Leases, (“FAS13”)* and, accordingly, recognizes current and long-term lease receivables, net of unearned income, on theaccompanying balance sheets. The present value of all payments is recorded as sales and the relatedcost of the equipment is charged to cost of sales. The associatedinterest is recorded over the term of the lease using the effective interest method**.** In many cases,GTSI transfers these receivables to various unrelated financing companies andaccounts for the transfers in accordance with SFAS No. 140, *Accounting for the Transfers and Servicing of Financial Assets andExtinguishments of Liabilities — a Replacement of FASB Statement 125*(“FAS 140”).

48

----

 

Thetransfer of receivables in which GTSI surrenders control is accounted for as asale. To surrender control, the assets must be isolated from the Company, thetransferee has the right to pledge or exchange the receivables and GTSI mustnot have an agreement that entitles and obligates the Company to repurchase thereceivables or the ability to unilaterally cause the holder to return specificassets. If the transfer of receivables does not meet the criteria for a saleunder FAS 140, the transfer is accounted for as a secured borrowing with apledge of collateral.  As a result, theCompany has recorded certain transferred receivables and secured borrowings,within accounts receivable and long-term financing receivables, and as financedlease debt on the balance sheet.

TheCompany may also enter into sales arrangements with customers where the Companyperforms as an agent or broker without assuming the risks and rewards ofownership of the goods and services. The Company recognizes revenue from thesetransactions on a net basis in accordance with EITF Issue No. 99-19, *Reporting Revenue Gross as a Principal versus Net as an Agent.*The Company sells third-party services, such as maintenance contracts, andrecognizes revenue on a net basis at the time of sale.

GTSIoffers rights of return to its customers on the products it sells. Inaccordance with SFAS No. 48, *Revenue Recognition WhenRight 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, 2005 was$8.1 million and was recorded as a reduction of accounts receivable, net. Thecost of sales of $7.3 million related to these sales were also deferred andrecorded on the consolidated balance sheet as of December 31, 2005 as deferredcosts.

Inaccordance with EITF Issue No. 02-16, *Accounting by a Customer(Including a Reseller) for Certain Consideration Received from a Vendor,*the Company records cash received from a vendor as a reduction of inventory anda subsequent reduction in cost of sales, unless the cash is a reimbursement ofa specific identifiable incremental cost or the vendor receives, or willreceive, an identifiable benefit in exchange for the cash.

Inaccordance with EITF Issue No. 00-10, *Accounting for Shippingand Handling Fees and Costs*, the Company records freight billed tocustomers as sales and the related shipping costs as cost of sales.

** D.  Cash**

Cash consists of all cash balances. As of December 31, 2005 and 2004approximately $9.6 million and $17.7 million, respectively, was included inaccounts payable which represented checks that were issued by the Company buthad not cleared its bank accounts, which would otherwise be considered a netoverdraft.

**E.  Concentration of Credit Risk**

Accountsreceivable principally represents amounts collectible from the U.S. FederalGovernment and prime contractors to the government. The Company periodicallyperforms credit evaluations of its non-governmental customers and generallydoes not require collateral. The allowance for non-collection of receivables isbased on specific identification of probable losses and an analysis ofhistorical trade receivable write-off experience. These valuation reserves arere-evaluated quarterly and adjusted as more information about the ultimatecollectibility of accounts receivable becomes available.

Asof December 31, 2005 and 2004, trade accounts receivable from the U.S. FederalGovernment were $126.6 million and $143.6 million, respectively. Of thesebalances, trade receivables from the Department of Defense accounted for 47.4%and 43.7% as of December 31, 2005 and 2004, respectively.  No other single U.S. Federal Governmentdepartment accounted for 10% or more of accounts receivable. Credit losses havebeen insignificant.

49

----

 

GTSIhas four major contracts that are up for re-compete in 2006.  As a result of the Company’s recent deliveryissues due to the implementation of the final phase of GEMS, management is notcertain that GTSI will obtain the re-competed awards.  During the year ended December 31, 2005,these contracts represented approximately 40% of sales and 35% of gross marginfor the Company.

**F.  Capitalized Internal Use Software Costs**

TheCompany capitalizes the cost of internal use software that has a useful life inexcess of one year in accordance with Statement of Position (“SOP”) No. 98-1, *Accounting for the Costs of Computer Software Developed or Obtained forInternal Use* (“SOP 98-1”). These costs consist of payments made tothird-parties and the salaries of employees working on such softwaredevelopment to customize it to the Company’s needs. Subsequent additions,modifications or upgrades to internal-use software are capitalized only to theextent that they allow the software to perform a task it previously did notperform. Software maintenance and training costs are expensed in the period inwhich they are incurred.

**G.  Long-Lived Assets**

Long-livedassets, consisting primarily of furniture, equipment and capitalized internaluse software 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 Impairmentor Disposal of Long-Lived Assets,* (“FAS 144”). Recoverability oflong-lived assets is assessed by a comparison of the carrying amount to theestimated future net cash flows expected to result from the use of the assetsand their eventual disposition. If estimated undiscounted future net cash flowsare less than the carrying amount, the asset is considered impaired and a losswould be recognized based on the amount by which the carrying value exceeds thefair value of the asset.

**H.  Accounts Payable**

FAS140 states that the judicial release from an obligation results in theextinguishment of a liability. Upon the expiration of the statute oflimitations in the year ended December 31, 2004, GTSI was judicially releasedfrom obligations which resulted in the Company derecognizing $10.1 million inaged accrued payables. The impact to GTSI’s financial results was a non-cashincrease to gross margin of $10.1 million and an increase to net income of $6.2million ($0.72 and $0.64 per basic and diluted share) after taxes were applied.

TheCompany purchases significant amounts of inventory each year and records anestimate of the payable based on the purchase orders issued as of the balancesheet date and the historic rate of purchase price variances, which is adjustedon a quarterly basis.  As invoices arereceived, the Company records adjustments for purchase price variances.  During the years ended December 31, 2005 and2004, changes in management’s estimate of the amount payable for itemspurchased resulted in $1.6 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”) in accounting for its stock option plans, which are more fullydescribed in Note 10. Generally, options are granted with an exercise priceequal to the fair market value of the Company’s common stock on the date of thegrant. The following table illustrates, in accordance with the provisions ofSFAS No. 148, *Accounting for Stock based Compensation —Transition and Disclosure* the effect on net (loss) income and (loss)earnings per share if compensation costs for the Company’s stock options hadbeen determined based on the fair value method in accordance with SFAS

50

----

 

No.123, *Accounting for Stock Based Compensation, (“FAS 123”)*for the years ended December 31, (in thousands, except per share data):

 
| ** **                                                                                                                                                                                     | ** ** | **2005  (restated  see Note 3)** | ** ** | **2004  (restated  see Note 3)** | ** ** | **2003  (restated  see Note 3)** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| Net (loss)  income—as reported                                                                                                                                                            |       | $                                          | (13,673    | )                                          | $          | 10,135                                     |       | $ | 3,318 |   |
| Add: Stock based  employee compensation cost included in net loss (income) as reported, net of  related tax effects                                                                            |       | —                                     |       | —                                     |       | 151                                        |       |
| 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) |       | (3,772                                     | )          | (2,153                                     | )          | (1,355                                     | )          |
| Net (loss)  income — pro forma                                                                                                                                                            |       | $                                          | (17,445    | )                                          | $          | 7,982                                      |       | $ | 2,114 |   |
|                                                                                                                                                                                           |       |                                       |       |                                       |       |                                       |       |
| (Loss) earnings  per share — as reported                                                                                                                                                  |       |                                       |       |                                       |       |                                       |       |
| Basic                                                                                                                                                                                          |       | $                                          | (1.49      | )                                          | $          | 1.17                                       |       | $ | 0.40 |   |
| Diluted                                                                                                                                                                                        |       | $                                          | (1.49      | )                                          | $          | 1.05                                       |       | $ | 0.36 |   |
| (Loss) earnings  per share — pro forma                                                                                                                                                    |       |                                       |       |                                       |       |                                       |       |
| Basic                                                                                                                                                                                          |       | $                                          | (1.90      | )                                          | $          | 0.92                                       |       | $ | 0.25 |   |
| Diluted                                                                                                                                                                                        |       | $                                          | (1.90      | )                                          | $          | 0.83                                       |       | $ | 0.23 |   |

 

Fordisclosure purposes, the fair value of each stock option granted is estimatedon the date of grant using the Black-Scholes-Merton option-pricing model. Thefair value of the Company’s stock based option awards to employees wasestimated assuming no expected dividends and the following weighted-averageassumptions for 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 of the optionsgranted during the years ended December 31, 2005, 2004 and 2003 was $3.59,$5.84 and $6.24, respectively.  Under theBlack-Scholes-Merton option pricing model, the total value of options grantedin the years ended December 31, 2005, 2004 and 2003 was $1.0 million, $2.9million and $3.9 million, respectively. The related pro forma compensationexpense is amortized on a straight line basis over the term specified in eachoption agreement.

Duringthe year ended December 31, 2004 the Company modified its definition of anemployee in its stock option plans. In accordance with Financial AccountingStandards Board (“FASB”) Interpretation No. 44, *Accountingfor Certain Transactions involving Stock Compensation, an interpretation of APB25*, (“FIN 44”) the Company accounted for these modified awards asnew awards to non-employees. As prescribed by FIN 44, the Company recordedstock based compensation of approximately $33 thousand and $480 thousand ($286thousand, net of taxes) during the years ended December 31, 2005 and 2004,respectively, for stock based compensation to non-employees based on the fairvalue method.  No stock compensationexpense to non-employees was included in net income in the year ended December31, 2003.

51

----

 

**J.  Income Taxes**

TheCompany accounts for income taxes in accordance with SFAS No. 109*, Accounting for Income Taxes* (“FAS 109”), which requiresthe recognition of deferred tax assets and liabilities for the expected futuretax effects of temporary differences between the carrying amounts of assets andliabilities for financial reporting purposes and the amounts used for incometax purposes. FAS 109 requires that a valuation allowance be established whenit is more likely than not that some portion or all of a deferred tax assetwill not be realized.  A valuationallowance on the net deferred tax asset has been recorded as of December 31,2005.

**K.  Use of Estimates**

Thepreparation of financial statements in conformity with U.S. generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities, the disclosure ofcontingent assets and liabilities at year end, and the reported amounts ofrevenue and expenses during the reporting period. Actual results could differfrom those estimates. Management’s estimates and assumptions are evaluated onan ongoing basis and are based on historical experience, current conditions andavailable information. Significant items subject to such estimates andassumptions include valuation allowances for receivables and deferred taxassets, impairments of capitalized internal use software, market value ofinventory, 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 purchases and/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 Value of Financial Instruments**

At December 31, 2005 and2004, the recorded values of financial instruments such as trade receivables,accounts payable and credit facility borrowings approximated their fair valuesbased 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 the measurement and recognition of compensationexpense for all stock based compensation payments and supersedes the Company’s currentaccounting under APB 25. In April 2005, the SEC adopted a new rule that amendsthe compliance date for FAS 123R to be effective as of the beginning of thefirst annual reporting period that begins after June 15, 2005. Thus, GTSIadopted the 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 of FAS123R.

Accordingly,the adoption of FAS 123R’s fair value method will have a significant impact onthe Company’s results of operations.  Theimpact to net income for the year ended December 31, 2006 cannot

52

----

 

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 gross stockcompensation 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 Note 10).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 flow in periodsafter adoption.

InJune 2005, the FASB issued SFAS No. 154, *Accounting Changes andError Corrections* (“FAS 154”) which is a replacement of APB OpinionNo. 20, *Accounting Changes* and SFAS No. 3, *Reporting Accounting Changes in Interim Financial Statements*.FAS 154 changes the accounting for and reporting of changes in accountingprinciples and error corrections by requiring retrospective application toprior period financial statements unless impracticable. This statement iseffective in fiscal years beginning after December 15, 2005. The Company doesnot expect the adoption of FAS 154 to have a significant impact on itsconsolidated financial statements.

**2. Going Concern**

The Company incurred a net loss of $13.7 million and used $109.5million of cash in operating activities during the year ended December 31,2005.  In addition, the Company has notcomplied with certain covenants of the Company’s $135 million revolving credit facility with a group of banks(the “Credit Facility”). A breach of any of the covenants or restrictionscontained in the Credit Facility would result in an event of default.  Such a default could allow the lenders todiscontinue lending or declare all borrowings outstanding to be due andpayable.  If any of these events occur,there is no assurance that GTSI will have sufficient funds available to pay infull the total amount of obligations that become due as a result of any suchacceleration, or that GTSI will be able to find additional or alternativefinancing to refinance any such accelerated obligations.  GTSI’s lenders have notified the Company thatthe Credit 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 16).

As of December 31,2005, GTSI’s cash was approximately $27 thousand.  The Company’s net working capital balance asof December 31, 2005 was approximately $60 million. In the absence of arevolving credit facility, management does not believe that GTSI’s existingcapital resources will enable the Company to fund operations on an ongoingbasis. Management plans to obtain alternative financing under a revolvingcredit facility with new lenders prior to the expiration of the current CreditFacility. We did not include any adjustments to the consolidated financialstatements 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. The following efforts are inprocess to secure suitable financing, improve working capital and increase cashflows which all will improve the long-term viability of the Company:

·                  On April 10, 2006 a commitment letter wassigned to negotiate a new revolving credit facility with two major money centerbanks by May 31, 2006, the expiration 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 February2006 to reduce our costs, eliminating over 100 full time positions; and

53

----

 

·                  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 fourthquarter of 2005, the Company developed a strategic plan to identify and exitfailing or non-strategic activities, improve execution of the current business,and emerge as a high-value solutions provider. The Company plans on focusingits many efforts, doing more profitable and strategic activities, and doingfewer activities which are either not profitable or non-strategic. Managementhas reviewed its various activities and eliminated or scaled back poorperforming sales teams and is in the process of focusing its marketing andsales efforts on the products, services and vendors which are most profitable.Management has reviewed the Company’s operations to eliminate duplicativeactivities and create lines of accountability. The Company is measuring theperformance of various customer teams and lines of business, and adjusting itsresources to ensure deployment to maximum advantage.

The implementationof the GEMS system in 2005 put significant strain on the Company and exposedseveral process inefficiencies throughout GTSI. Management believes it canreduce operating costs, improve customer service and improve cash flow througha concerted effort to improve the supply chain and delivery processes.Management recently aligned GTSI to put all supply-chain and IT activities inone organization to drive the various initiatives to realize the benefits ofimproved execution.

While larger salestransactions represent a small percentage of GTSI’s total transactions, theyrepresent the majority of the Company’s gross margin. Going forward, GTSI willcontinue to focus on these larger, more profitable transactions, and driveprocesses and changes to make the delivery of the smaller transactions moreprofitable.

In addition, GTSI will continue to take other actionsto create and maintain a profitable company. Specifically, the Company expectsto focus on the growing government IT market, execute new government contractsand utilize flexible contract vehicles, provide a high-quality centralizedsource for procuring it products and services, and establish and maintainstrong vendor relationships.

**3. Restatement of Financial Statements**

Duringthe second half of 2006, the Company concluded its consolidated financialstatements as of December 31, 2005, 2004 and 2003 and all quarters of the yearsthen ended should be restated to correct its accounting for: a) the transfer ofcertain receivables to third parties in accordance with FAS 140, b)overstatement of accounts payable and the related cost of sales, and c) therecording of miscellaneous accounting adjustments appropriate for the fairpresentation of the financial statements.

Followingthe restatement, income on certain transferred receivables is being recognizedover the term of the respective lease agreements, along with interest expenseon financed lease debt. The impact of these restatement adjustments is todecrease net loss by $2.3 million for the year ended December 31, 2005,decrease net income $0.1 million for the year ended December 31, 2004, andincrease net income $0.1 million for the year ended December 31, 2003. Inaddition, certain transferred receivables together with related liabilities arereported in GTSI’s balance sheets following the restatement. These restatemententries resulted in an increase of $39.3 million and $17.5 million in totalassets as of December 31, 2005 and 2004, respectively and total liabilitiesincreased $35.8 million as of December 31, 2005 and $17.2 million as ofDecember 31, 2004.  Additionally, therestatement entries affected the Statement of Cash Flows by moving an equalamount of cash flows from operations to cash flows from financing activities,resulting in a reclassification of $68.8 million and $30.0 million for theyears ended December 31, 2005 and 2004, respectively.

54

----

Thefollowing tables summarize the effects of these adjustments on the Company’sconsolidated balance sheets as of December 31, 2005 and 2004 and consolidatedstatements of operations for the years ended December 31, 2005, 2004 and 2003.

Consolidated Balance SheetDecember 31, 2005(in thousands)
| ** **                                        | ** ** | **As Previously** | ** ** | ** **     | ** ** | ** **    | ** ** | ** **           | ** ** |
|---------------------------------------------------|------------|------------------------|------------|----------------|------------|---------------|------------|----------------------|------------|
| ** **                                        | ** ** | **Reported**           | ** ** | **Adjustment** | ** ** | **Reference** | ** ** | **As Restated** | ** ** |
| Cash                                              |       | $                      | 22         |           | $          | 5             |       | c                    |       | $ | 27 |   |
| Accounts receivable,  net                         |       | $                      | 207,886    |           | $          | 18,470        |       | a,c                  |       | $ | 226,356 |   |
| Inventory                                         |       | $                      | 56,666     |           | $          | 153           |       | b,c                  |       | $ | 56,819 |   |
| Deferred costs                                    |       | $                      | 14,909     |           | $          | 2,160         |       | a,c                  |       | $ | 17,069 |   |
| Other current assets                              |       | $                      | 9,118      |           | $          | (513          | )          | c                    |       | $ | 8,605 |   |
| Total current assets                              |       | $                      | 288,601    |           | $          | 20,275        |       | a,b,c                |       | $ | 308,876 |   |
| Long-term financing  receivables and other assets |       | $                      | 4,416      |           | $          | 18,975        |       | a                    |       | $ | 23,391 |   |
| Total assets                                      |       | $                      | 306,657    |           | $          | 39,250        |       | a,b,c                |       | $ | 345,907 |   |
| Accounts payable                                  |       | $                      | 159,038    |           | $          | (7,043        | )          | b,c                  |       | $ | 151,995 |   |
| Financed lease debt                               |       | —                 |       | $              | 25,187     |          | a          |                 | $          | 25,187 |   |
| Accrued liabilities                               |       | $                      | 16,634     |           | $          | (31           | )          | c                    |       | $ | 16,603 |   |
| Deferred revenue                                  |       | $                      | 3,611      |           | $          | 2,409         |       | a,c                  |       | $ | 6,020 |   |
| Accrued warranty  liabilities                     |       | $                      | 744        |           | $          | 105           |       | c                    |       | $ | 849 |   |
| Total current  liabilities                        |       | $                      | 228,041    |           | $          | 20,627        |       | a,b,c                |       | $ | 248,668 |   |
| Long-term financed  lease debt                    |       | —                 |       | $              | 15,996     |          | a          |                 | $          | 15,996 |   |
| Other liabilities                                 |       | $                      | 3,922      |           | $          | (846          | )          | c                    |       | $ | 3,076 |   |
| Total liabilities                                 |       | $                      | 231,963    |           | $          | 35,777        |       | a,b,c                |       | $ | 267,740 |   |
| Capital in excess of  par value                   |       | $                      | 42,943     |           | $          | 2,161         |       | c                    |       | $ | 45,104 |   |
| Retained earnings                                 |       | $                      | 34,396     |           | $          | 2,335         |       | a,b,c                |       | $ | 36,731 |   |
| Treasury stock                                    |       | $                      | (2,694     | )              | $          | (1,023        | )          | c                    |       | $ | (3,717 | ) |
| Total stockholders’  equity                  |       | $                      | 74,694     |           | $          | 3,473         |       | a,b,c                |       | $ | 78,167 |   |
| Total liabilities and stockholders’ equity   |       | $                      | 306,657    |           | $          | 39,250        |       | a,b,c                |       | $ | 345,907 |   |

 

Consolidated Statement of OperationsFor the Year Ended December 31,2005(in thousands, except per share data)
| Sales                                    |   | $      | 886,263 |   | $      | (4,251 | )      | a,c    |   | $        | 882,012 |   |
|------------------------------------------|--------|--------|---------|--------|--------|--------|--------|--------|--------|----------|---------|--------|
| Cost of sales                            |   | $      | 791,346 |   | $      | (9,136 | )      | b,c    |   | $        | 782,210 |   |
| Gross margin                             |   | $      | 94,917  |   | $      | 4,885  |   | a,b,c  |   | $        | 99,802  |   |
| Selling, general  & administrative   |   | $      | 119,451 |   | $      | (80    | )      | c      |   | $        | 119,371 |   |
| Loss from  operations                    |   | $      | (25,515 | )      | $      | 4,965  |   | a,b,c  |   | ($20,550 | )       |
| Interest and  other income, net          |   | $      | 6,729   |   | $      | (3,078 | )      | a      |   | $        | 3,651   |   |
| Loss before  income taxes                |   | $      | (18,786 | )      | $      | 1,887  |   | a,b,c  |   | $        | (16,899 | )      |
| Income tax  benefit                      |   | $      | 2,787   |   | $      | 439    |   | a,b,c  |   | $        | 3,226   |   |
| Net loss                                 |   | $      | (15,999 | )      | $      | 2,326  |   | a,b,c  |   | $        | (13,673 | )      |
|                                     |   |   |    |   |   |   |   |   |   |
| Loss per share — basic  and diluted |   | $      | (1.74   | )      | 0.25   |   | a,b,c  |   | $      | (1.49    | )       |

 

55

----

Consolidated Balance SheetDecember 31, 2004(in thousands)
| ** **                                        | ** ** | **As Previously  Reported** | ** ** | **Adjustment** | ** ** | **Reference** | ** ** | **As Restated** | ** ** |
|---------------------------------------------------|------------|----------------------------------|------------|----------------|------------|---------------|------------|----------------------|------------|
| Cash                                              |       | $                                | 397        |           | $          | (10           | )          | c                    |       | $ | 387 |   |
| Accounts  receivable, net                         |       | $                                | 204,842    |           | $          | 12,290        |       | a                    |       | $ | 217,132 |   |
| Inventory                                         |       | $                                | 59,184     |           | $          | (114          | )          | c                    |       | $ | 59,070 |   |
| Deferred costs                                    |       | $                                | 4,218      |           | $          | 716           |       | a,c                  |       | $ | 4,934 |   |
| Other current  assets                             |       | $                                | 11,162     |           | $          | (5,277        | )          | a,c                  |       | $ | 5,885 |   |
| Total current  assets                             |       | $                                | 279,803    |           | $          | 7,605         |       | a,c                  |       | $ | 287,408 |   |
| Long-term  financing receivables and other assets |       | $                                | 1,400      |           | $          | 9,917         |       | a                    |       | $ | 11,317 |   |
| Total assets                                      |       | $                                | 296,386    |           | $          | 17,522        |       | a,c                  |       | $ | 313,908 |   |
| Borrowings under  credit facility                 |       | $                                | 1,179      |           | $          | (11           | )          | c                    |       | $ | 1,168 |   |
| Accounts payable                                  |       | $                                | 173,218    |           | $          | (1,409        | )          | b                    |       | $ | 171,809 |   |
| Financed lease  debt                              |       | $                                | —     |           | $          | 8,645         |       | a                    |       | $ | 8,645 |   |
| Accrued  liabilities                              |       | $                                | 14,734     |           | $          | 122           |       | c                    |       | $ | 14,856 |   |
| Deferred revenue                                  |       | $                                | 9,216      |           | $          | 271           |       | a,c                  |       | $ | 9,487 |   |
| Total current  liabilities                        |       | $                                | 200,776    |           | $          | 7,618         |       | a,b,c                |       | $ | 208,394 |   |
| Long-term  financed lease debt                    |       | $                                | —     |           | $          | 9,273         |       | a                    |       | $ | 9,273 |   |
| Other  liabilities                                |       | $                                | 3,473      |           | $          | 353           |       | c                    |       | $ | 3,826 |   |
| Total  liabilities                                |       | $                                | 204,249    |           | $          | 17,244        |       | a,b,c                |       | $ | 221,493 |   |
| Capital in  excess of par value                   |       | $                                | 46,817     |           | $          | 230           |       | c                    |       | $ | 47,047 |   |
| Retained  earnings                                |       | $                                | 50,395     |           | $          | 9             |       | a,b,c                |       | $ | 50,404 |   |
| Treasury stock                                    |       | $                                | (5,124     | )              | $          | 39            |       | c                    |       | $ | (5,085 | ) |
| Total  stockholders’ equity                  |       | $                                | 92,137     |           | $          | 278           |       | a,b,c                |       | $ | 92,415 |   |
| Total  liabilities and stockholders’ equity  |       | $                                | 296,386    |           | $          | 17,522        |       | a,b,c                |       | $ | 313,908 |   |

 

Statement of Operations

For the Year Ended December 31, 2004

(in thousands, except pershare data)
| Sales                                  |   | $      | 1,076,148 |   | $      | (711   | )      | a,c    |   | $ | 1,075,437 |   |
|----------------------------------------|--------|--------|-----------|--------|--------|--------|--------|--------|--------|---|-----------|--------|
| Cost of sales                          |   | $      | 954,143   |   | $      | (798   | )      | a,b,c  |   | $ | 953,345   |   |
| Gross margin                           |   | $      | 122,005   |   | $      | 87     |   | a,b,c  |   | $ | 122,092   |   |
| Selling, general  & administrative |   | $      | 110,855   |   | $      | (840   | )      | c      |   | $ | 110,015   |   |
| Income from  operations                |   | $      | 11,150    |   | $      | 927    |   | a,b,c  |   | $ | 12,077    |   |
| Interest and  other income, net        |   | $      | 5,569     |   | $      | (653   | )      | a      |   | $ | 4,916     |   |
| Income before  income taxes            |   | $      | 16,719    |   | $      | 274    |   | a,b,c  |   | $ | 16,993    |   |
| Income tax  provision                  |   | $      | (6,455    | )      | $      | (403   | )      | a,b,c  |   | $ | (6,858    | )      |
| Net income                             |   | $      | 10,264    |   | $      | (129   | )      | a,b,c  |   | $ | 10,135    |   |
|                                   |   |   |      |   |   |   |   |   |   |
| Earnings per  share — basic       |   | $      | 1.18      |   | $      | (0.01  | )      | a,b,c  |   | $ | 1.17      |   |
| Earnings per share —  diluted     |   | $      | 1.09      |   | $      | (0.04  | )      | a,b,c  |   | $ | 1.05      |   |

 

56

----

Statementof Operations

Forthe Year Ended December 31, 2003

(in thousands, except pershare data)
| ** **                                      | ** ** | **As Previously  Reported** | ** ** | **Adjustment** | ** ** | **Reference** | ** ** | **As Restated** | ** ** |
|-------------------------------------------------|------------|----------------------------------|------------|----------------|------------|---------------|------------|----------------------|------------|
| Sales                                           |       | $                                | 954,118    |           | $          | (2,607        | )          | a                    |       | $ | 951,511 |   |
| Cost of sales                                   |       | $                                | 857,334    |           | $          | (3,980        | )          | a,b                  |       | $ | 853,354 |   |
| Gross margin                                    |       | $                                | 96,784     |           | $          | 1,373         |       | a,b                  |       | $ | 98,157 |   |
| Selling, general  & administrative expenses |       | $                                | 88,347     |           | $          | 859           |       | c                    |       | $ | 89,206 |   |
| Income from operations                          |       | $                                | 2,465      |           | $          | 514           |       | a,b                  |       | $ | 2,979 |   |
| Interest and  other income, net                 |       | $                                | 2,832      |           | $          | 105           |       | a                    |       | $ | 2,937 |   |
| Income before  income taxes                     |       | $                                | 5,297      |           | $          | 619           |       | a,b                  |       | $ | 5,916 |   |
| Income tax  provision                           |       | $                                | (2,118     | )              | $          | (480          | )          | a,b                  |       | $ | (2,598 | ) |
| Net income                                      |       | $                                | 3,179      |           | $          | 139           |       | a,b                  |       | $ | 3,318 |   |
|                                            |       |                             |       |           |       |          |       |                 |       |
| Earnings per  share — basic                |       | $                                | 0.38       |           | $          | 0.02          |       | a,b                  |       | $ | 0.40 |   |
| Earnings per share —  diluted              |       | $                                | 0.35       |           | $          | 0.01          |       | a,b                  |       | $ | 0.36 |   |

 

These restatements did not have any effect on investing cash flows. Theimpact on operating and financing cash flows primarily resulting from certaintransfers of lease receivables being considered secured borrowings rather thansales, is detailed in the chart below (in thousands):
| ** ** | ** ** | ** **            | ** ** | **As Reported** | ** ** | **Adjustment** | ** ** | **As Restated** | ** ** |
|------------|------------|-----------------------|------------|----------------------|------------|----------------|------------|----------------------|------------|
| 2005       |       | Operating cash  flows |       | $                    | (42,020    | )              | $          | (68,806              | )          | $ | (110,826 | ) |
| 2005       |       | Financing cash  flows |       | $                    | 45,333     |           | $          | 68,821               |       | $ | 114,154 |   |
| 2004       |       | Operating cash  flows |       | $                    | 16,818     |           | $          | (30,019              | )          | $ | (13,201 | ) |
| 2004       |       | Financing cash  flows |       | $                    | (9,063     | )              | $          | 30,009               |       | $ | 20,946 |   |
| 2003       |       | Operating cash  flows |       | $                    | 4,583      |           | $          | (9,098               | )          | $ | (4,515 | ) |
| 2003       |       | Financing cash flows  |       | $                    | 3,435      |           | $          | 9,098                |       | $ | 12,533 |   |

 

SeeNote 17 to the consolidated financial statements for the impact of therestatement on quarterly information for the years ended December 31, 2005 and2004.

**a) Transfer of certain receivables in accordance with FAS 140**

FAS 140 provides for the treatment oftransfers of assets at the time of transfer as sales, provided the seller meetscertain criteria and surrenders control over the asset. Management concluded inAugust 2006 that certain transfers did not qualify as sales under FAS 140because the transfer agreements allowed GTSI to maintain effective control overthe transferred assets. As the transfers did not qualify as sales under FAS140, the Company should not have derecognized the assets at the time of thetransfer. Therefore, the transferred receivables, together with relatedliabilities, are reported in the Company’s balance sheet as accounts receivableand long-term financing receivables and financed lease debt.  In addition, corrections for the timing ofgains recognized on the transfer of financing receivables, recorded aslease-related income on the Statement of Operations, were deemed necessary torecognize the interest income on the retained receivables and interest expenseon financed lease debt over the term of the related arrangements.

b) **Overstatement of certain accounts payable and the related cost of sales**

As a result of certainsystems and process related errors, several instances of overstatement ofaccounts payable and the related cost of sales were identified during a reviewof aged payable balances.

57

----

**c)****Other — Recording of miscellaneous accounting adjustments**

The Company has made other less significantcorrections to various other accounts that are appropriate for the fairpresentation of the Company’s 2005, 2004 and 2003 financial statements.

**4.  Accounts Receivable**

Accounts receivable consists of the following as ofDecember 31 (in thousands):
| ** **                                     | ** ** | **2005  (restated  see Note 3)** | ** ** | **2004  (restated  see Note 3)** | ** ** |
|------------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| Billed and unbilled  trade accounts receivable |       | $                                          | 202,788    |                                       | $          | 196,982 |   |
| Lease  receivables, net                        |       | 33,131                                     |       | 20,014                                     |       |
| Vendor and other  receivables                  |       | 521                                        |       | 1,145                                      |       |
| Total accounts receivable                      |       | 236,440                                    |       | 218,141                                    |       |
| Less: Allowance  for doubtful accounts         |       | (1,968                                     | )          | (1,009                                     | )          |
| Sales return allowance                         |       | (8,116                                     | )          | —                                     |       |
| Accounts  receivable, net                      |       | $                                          | 226,356    |                                       | $          | 217,132 |   |

 

Vendorand other receivables primarily result from items billed to suppliers undervarious sales incentive programs.

**5.  Lease Receivables**

The Company offers leasearrangements to its customers. These arrangements typically have terms from twoto four years and are accounted for as sales-type leases under FAS 13. TheCompany’s net investment in leases were as follows as of December 31 (inthousands)

|                                           | ** ** | **2005  (restated  see Note 3)** | ** ** | **2004  (restated  see Note 3)** | ** ** |
|-------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| Future minimum  lease payments receivable |       | $                                          | 30,736     |                                       | $          | 19,323 |   |
| Unguaranteed  residual values             |       | 8,723                                      |       | 2,988                                      |       |
| Unearned income                           |       | (6,328                                     | )          | (2,297                                     | )          |
| Net investment in  leases                 |       | $                                          | 33,131     |                                       | $          | 20,014 |   |

 

Future minimum lease payment receivables are asfollows as of December 31, 2005 (in thousands).

| Year                                      | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------------|------------|------------|------------|------------|------------|
| 2006                                      |       | $          | 21,742     |       |
| 2007                                      |       | 6,649      |       |
| 2008                                      |       | 1,626      |       |
| 2009                                      |       | 719        |       |
| 2010                                      |       | —     |       |
| Thereafter                                |       | —     |       |
| Future minimum lease  payments receivable |       | $          | 30,736     |       |

 

58

----

**6.   Financing Receivables and Financed LeaseDebt**

TheCompany recognized sales of $65.5 million, $34.5 million and $22.8 million forthe years ended December 31, 2005, 2004 and 2003 from sales-type leasetransactions.  The receivables thatresult from these sales-type leases are reported by the Company in itsconsolidated balance sheets as lease receivables (see Note 5), and as financingreceivables. Current financing receivables are included in accounts receivablenet, while the long-term amounts are included in long-term financingreceivables and other assets. The interest income on the lease receivables, thefinancing receivables, as well as the gains on the receivables transferred tothird parties and accounted for as sales under FAS 140, is recognized in theaccompanying statements of operations as lease-related income.

*Financing Receivables*

Asof December 31, 2005 and 2004, $50.1 million and $26.4 million of lease andother related receivables have been transferred to third party financingcompanies.  Though the Company receivedcash for the transfer of these receivables, the transfers did not meet thecriteria for a sale under FAS 140.  As aresult, the lease and other related receivables remain on the Company’s balancesheets and are characterized as financing receivables. The interest income onthe financing receivables is recognized ratably over the terms of therespective agreements as lease-related income.

The financing receivablestypically have terms from two to four years and are usually collateralized by asecurity interest in the underlying assets. The components of net financingreceivables which are included in accounts receivable and long-term financingreceivables and other assets were as follows as of December 31 (in thousands):

|                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------|------------|----------|------------|----------|------------|
|                               |       |     |       |     |       |
| Minimum lease  payments receivable |       | $        | 41,493     |     | $          | 22,902 |   |
| Unguaranteed  residual value       |       | 8,628    |       | 2,161    |       |
| Unearned income                    |       | (8,569   | )          | (2,355   | )          |
| Financing  receivables, net        |       | 41,552   |       | 22,709   |       |
| Less current  portion              |       | (23,524  | )          | (15,142  | )          |
| Amount due after one  year, net    |       | $        | 18,028     |     | $          | 7,567 |   |

 

*Financed Lease Debt*

Asthe transfers of the financing receivables did not meet the sale criteria underFAS 140, the receipts of cash from the third party financing companies areaccounted for as secured borrowings, which are included in the accompanyingconsolidated balance sheets as financed lease debt.   The Company has received cash of $67.1million and $19.3 million for the years ended December 31, 2005 and 2004,respectively, related to the transfer of the financing receivables to thirdparties.

Theterms of the financed lease debt generally correspond to the terms of theunderlying lease agreements, generally two to four years.  In addition, the secured financed debt had aweighted average interest rate of 6.83%, 5.89% and 5.03% as of December 31,2005, 2004 and 2003, respectively.  Thesecured financed debt is secured by the related lease and otherreceivables.   The Company recognized$1.6 million, $0.6 million and $0.3 million of interest expense associated withthe secured financed debt for the years ended December 31, 2005, 2004 and 2003.

59

----

The maturities of the financed lease debt as of December 31, 2005 areas follows:

| Year  | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------|------------|------------|------------|------------|------------|
| 2006  |       | $          | 25,187     |       |
| 2007  |       | 9,399      |       |
| 2008  |       | 3,501      |       |
| 2009  |       | 3,096      |       |
| Total |       | $          | 41,183     |       |

 

*Transferred Receivables*

Forthe years ended December 31, 2005, 2004 and 2003, the Company transferred leaseand other related receivables of $7.5 million, $22.6 million and $8.4 million,respectively to third party financing companies in transactions that met thesale criteria under FAS 140.  As such,the Company derecognized the receivables associated with these transfers, andrecorded a resulting gain included in lease-related income on the accompanyingconsolidated statements of operations.

**7.  Inventory**

Inventoryis valued at the lower of cost or market. Cost is determined using the weightedaverage method. The Company writes down its inventory for obsolete or excessinventory based on assumptions about future demand and market conditions. Thedifficulties arising from the implementation of GEMS distracted personnel fromthe management of procurement and inventory. That problem was compounded byGEMS issues which resulted in ordering excess inventory. As a result, duringthe year ended December 31, 2005 the Company recorded an impairment charge of$5.6 million for obsolete and excess inventory, which is included in cost ofsales. This expense increased the Company’s loss from operations by $5.6million. During the year ended December 31, 2004, GTSI recorded a charge of$0.7 million, net of insurance proceeds, in cost of sales for inventory losses.

**8.  Depreciable Assets**

Depreciable assets are stated at cost less accumulated depreciation andamortization. Depreciation and amortization are calculated using thestraight-line method over estimated useful lives. Purchased and developedcomputer software for internal use, including the GTSI Enterprise ResourceManagement System (“GEMS”), are amortized over expected lives ranging fromthree to seven years.  Furniture andequipment useful lives range from three to ten years. The useful life forleasehold improvements is the lesser of the term of the lease or the life ofthe improvement, which range from 3 to 9 years. Costs for maintenance andrepairs are charged to expense when incurred. Depreciable assets consist of thefollowing as of December 31 (in thousands):

|                                                 | ** ** | **2005  (restated  see Note 3)** | ** ** | **2004  (restated  see Note 3)** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| 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 |   |

 

60

----

OnApril 18, 2005 GTSI replaced its legacy fulfillment system by implementing thesupply chain management modules of GEMS. During the years ended December 31, 2005and 2004, the Company capitalized $2.1 million and $5.5 million, respectivelyof development costs related to GEMS. In addition, during the years endedDecember 31, 2005 and 2004 the Company capitalized $0.7 million and $0.1million, respectively, for other purchased software for internal use.

Duringthe year ended December 31, 2005 the Company decided to use a web-basedcustomer resource management (“CRM”) software instead of the CRM module ofGEMS. As a result, the Company tested certain asset groupings within GEMS forrecoverability and determined an impairment loss of approximately $1.0 million,net of accumulated amortization, should be recorded in operating expenses towrite down GEMS to its fair value as required by FAS 144.

Duringthe year ended December 31, 2003 the Company changed its strategy regardingGEMS from a highly customized enterprise resource planning (“ERP”) system to astandard ERP system to compress the delivery time and provide significant valuesooner. Due to this change in strategy, the Company recorded an impairmentcharge of approximately $6.0 million for capitalized customization expensesdetermined to have no future economic value.

**9.  Credit Facility**

Asof December 31, 2005 the Company had a $135 million revolving Credit Facilitywith a group of banks that expires on May 31, 2006. The Credit Facilityincludes a revolving line of credit (the “Revolver”) and a provision forinventory financing of vendor products (the “Wholesale Financing Facility”).Borrowing under the Revolver is limited to 85% of eligible accounts receivable.The Revolver is secured by substantially all of the Company’s assets. Borrowingunder the Wholesale Financing Facility is limited to 100% of the value of GTSI’sinventory and was $29.5 million as of December 31, 2005 and is included inaccounts payable in the accompanying consolidated balance sheets. The WholesaleFinancing Facility is secured by the underlying inventory. The Credit Facilitycarried an interest rate indexed to the London Interbank Offered Rate (“LIBOR”)plus 1.75 percentage points. The Credit Facility also contains certaincovenants as well as provisions specifying compliance with certain quarterlyand annual financial ratios.

Duringthe year ended December 31, 2005, GTSI signed four amendments to the CreditFacility to change the size of the facility, add additional lenders to thesyndicate, change certain debt covenants, and extend the expiration date.During the year ended December 31, 2004, the Company and its lenders signedthree amendments to the Credit Facility to add a new lender and add GTSI’swholly owned subsidiaries, TLI and GTSI Financial Services, as borrowers.

AtDecember 31, 2005 and 2004, GTSI’s interest rate under the Credit Facility was6.1% and 4.2%, respectively.  The weightedaverage interest rates for the years ended December 31, 2005, 2004 and 2003were 5.1%, 3.2% and 3.0%, respectively.

GTSIwas in compliance with all financial covenants set forth in the Credit Facilityas of December 31, 2005. However, as of January 31, 2006, the Company defaultedon the following financial covenants under the Credit Facility: (i) maximumfunded indebtedness to EBITDA, (ii) minimum EBIT to net sales and, (iii)minimum tangible net worth. GTSI’s lenders requested the execution of an agreementto temporarily forbear them from enforcing their rights and remedies as aresult of 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 16 for additional details

61

----

anddisclosure related to the Credit Agreement. On April 3, 2006, GTSI defaulted ona covenant under the Credit Agreement when the Company received a staffdetermination letter from the NASDAQ National Market stating that because GTSIhad not filed its Annual Report on Form 10-K for 2005 with the SEC, as requiredby Market Place Rule 4310(c)(14), GTSI’s common stock is subject to delistingfrom 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 no assurance, managementexpects to avoid delisting of the Company’s common stock from the NASDAQNational Market by the filing of this Form 10-K. The Company had availablecredit of $41.2 million as of December 31, 2005 and $59.0 million as ofDecember 31, 2004.

**10.  Stockholders’ Equity**

*Purchase of Capital Stock*

Duringthe years ended December 31, 2005, 2004 and 2003, the Company purchasedapproximately 610 thousand, zero, and 600 thousand shares, respectively ofcommon stock for $4.9 million, $0, and $5.0 million, respectively. The shares purchasedwere authorized under a stock purchase plan approved by GTSI’s Board ofDirectors. In February 2000, the Board of Directors approved a plan for thepurchase of common stock with a limit of up to $5.25 million. In January 2002,the Board of Directors authorized the use of up to an additional $5.0 millionfor the purchase of outstanding shares of the Company’s common stock, providedthe per share price did not exceed the market price. During the year endedDecember 31, 2005, the Board of Directors approved a $7.3 million increase tothe Company’s share repurchase program.

Asof December 31, 2005, GTSI had authorization for remaining future repurchasesof $5.1 million; however, due to the events of default under its CreditFacility as of January 31, 2006, the Company is currently restricted frompurchasing its stock.Commonstock purchased for the Company’s treasury is generally reissued for theemployee stock purchase plan, for restricted stock grants and upon the exerciseof employee stock options.

*Stock Incentive Plans*

TheCompany has two stockholder approved combination incentive and non-statutorystock incentive plans, the 1994 Stock Option Plan, as amended (“1994 Plan”) andthe Amended and Restated 1996 Stock Incentive Plan (“1996 Plan”). These plansprovide for the granting of options to employees (both plans) and non-employeedirectors (only under the 1996 Plan) to purchase up to 300,000 and 3,500,000shares, respectively, of the Company’s common stock. The 1996 Plan was amendedduring the year ended December 31, 2005 to provide for grants to Companyemployees and non-employee directors of restricted stock, restricted stockunits and performance awards in cash or common stock. The Company has anotherstockholder approved plan, the 1997 Non-Officer Stock Option Plan (the “1997Plan”) which provides for the granting of non-statutory stock options toemployees (other than officers and directors) to purchase up to 300,000 sharesof the Company’s common stock. In addition, GTSI has utilized a vehicle permittedunder NASDAQ marketplace rules that allows a company without stockholderapproval to offer stock options to prospective employees as an inducement tojoin GTSI (the “Capitalization Vehicle”).

Underthe 1997, 1996, and 1994 Plans, options have a term of up to ten years,generally vest over four years and option prices are required to be at not lessthan 100% of the fair market value of the Company’s common stock at the date ofgrant and, except in the case of non-employee directors, must be approved bythe Board of Directors or its Compensation Committee.  Options issued under the CapitalizationVehicle have a term of seven years, vest over four years and option pricesequal 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.

62

----

*Stock Options*

The following summary presents changes in the Company’s stock optionsoutstanding under 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 as of 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 as of 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 as of December 31, 2005  |       | 2,088,350                          |       | $                                                      | 8.57       |   |

 

The followingtable summarizes information on stock options outstanding as of 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 |   |

 

63

----

The followingtable sets forth the number of options exercisable and available for grant asof 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                                      |       |

 

The followingtable 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,officers and directors under GTSI’s stock option plans. This action affectedunvested options to purchase an aggregate of 515 thousand shares of commonstock at exercise prices per share between $8.23 and $13.67. The vesting ofthese options was accelerated to avoid recognizing compensation expense infuture financial statements upon the adoption of FAS 123R.

In January 2003, the Company agreed that the unvestedoptions held by one officer would automatically vest if a change in control ofthe Company occurs. The maximum compensation expense impact, if any, related tothis change is $0.8 million. This change results in a new measurement date asrequired by FIN 44. No compensation expense was recorded as a result of thismodification at that time or to date because the Company is unable to concludethat a change in control is likely to occur. The compensation expense, ifrecorded, would not impact the Company’s cash flows or stockholders’ equity.

During the quarter ended December 31, 2005 anexecutive exercised 200,000 stock options and received 64,718 shares of companystock in a net share settlement, for which mature shares were effectively tendered.During the year ended December 31, 2003, an executive submitted Companymature stock with a value of $1.1 million previously purchased on the openmarket to pay for the exercise of 100,000 stock options pursuant to the termsof the Company’s stock option plan, which resulted in a cashless exchange ofstock options for Company stock.

*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. There were also 5,001shares of restricted stock issued to employees in 2005 under the 1996 planwhich vest equally over four years. In addition to the grants to employeesabove, the Company as authorized by its Board of Directors, issued restrictedstock grants of 26,664 shares of the Company’s common stock to the non-employeemembers of the Board during the year ended December 31, 2005. Theserestricted shares are scheduled to vest on June 10, 2006. At December 31,2005, 49,998 shares remain restricted.

64

----

The weighted-average grant date fair value ofrestricted stock granted during the year ended December 31, 2005 was $8.15per share. There were no restricted stock shares issued in 2004 or 2003.Unearned compensation, a component of stockholders equity, was recorded at thedate of the restricted stock awards based on the market value of the shares.Compensation cost is recognized ratably over the vesting period and unearnedcompensation is reduced as compensation expense is recorded and as forfeituresoccur. The Company recorded $407 thousand in stockholders’ equity for deferredcompensation during the year ended December 31, 2005. No deferredcompensation was recorded during the year ended December 31, 2004. Duringthe year ended December 31, 2005, $153 thousand was recorded as stockbased compensation expense for restricted stock, resulting in a remainingunearned compensation balance for restricted stock of $254 thousand as of December 31,2005.

*Employee Stock Purchase 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 offering periodis equal to 5% of such employee’s compensation for the 12 calendar-month periodprior to the commencement of an offering period divided by 85% of the fairmarket 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 thelower of the fair market value of a share of common stock on the first day orthe last day of the offering period. The Company uses its treasury shares tofulfill the obligation of both the employee withholding and the discount.

The table belowsummarizes the number of shares purchased by employees under the ESPP duringthe offering periods indicated:

| Offering period ended | ** ** | **Number of  shares  purchased** | ** ** | **Purchase  price** | ** ** |
|---------------------------------|------------|---------------------------------------|------------|---------------------|------------|
| December 31, 2005          |       | 41,605                                |       | $                   | 5.95       |   |
| June 30, 2005                   |       | 35,612                                |       | $                   | 6.92       |   |
| 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       |   |

 

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 reserved1,600,000 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 thepurchase price is 95% of the fair market value of a share of common stock onthe last day of the offering period, effective January 1, 2006 going forward.No other material changes were made to the plan.

**11.  Earnings Per 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 26 thousand have beenexcluded for the year ended December 31, 2005.

65

----

The followingtable sets forth the computation of basic and diluted (loss) earnings per share(in thousands, except per share amounts) for the years ended December 31:
| ** **                                                                            | ** ** | **2005  (restated  see Note 3)** | ** ** | **2004  (restated  see Note 3)** | ** ** | **2003  (restated  see Note 3)** | ** ** |
|---------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| Basic (loss) earnings  per share:                                                     |       |                                       |       |                                       |       |                                       |       |
| Net (loss)  income                                                                    |       | $                                          | (13,673    | )                                          | $          | 10,135                                     |       | $ | 3,318 |   |
| Weighted average  shares outstanding                                                  |       | 9,166                                      |       | 8,664                                      |       | 8,343                                      |       |
| Basic (loss)  earnings per share                                                      |       | $                                          | (1.49      | )                                          | $          | 1.17                                       |       | $ | 0.40 |   |
|                                                                                  |       |                                       |       |                                       |       |                                       |       |
| Diluted (loss) earnings  per share:                                                   |       |                                       |       |                                       |       |                                       |       |
| Net (loss)  income                                                                    |       | $                                          | (13,673    | )                                          | $          | 10,135                                     |       | $ | 3,318 |   |
| Weighted average  shares outstanding                                                  |       | 9,166                                      |       | 8,664                                      |       | 8,343                                      |       |
| Incremental  shares attributable to the assumed exercise of outstanding stock options |       | N/A                                        |       | 954                                        |       | 965                                        |       |
| Weighted average  shares and equivalents                                              |       | 9,166                                      |       | 9,618                                      |       | 9,308                                      |       |
| Diluted (loss) earnings  per share                                                    |       | $                                          | (1.49      | )                                          | $          | 1.05                                       |       | $ | 0.36 |   |

 

**12.  Income Taxes**

The provision forincome taxes consists of the following (in thousands):

|                                      | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------------------|------------|---------------------------------------------|------------|
| ** **                           | ** ** | **2005  (restated  see Note 3)**  | ** ** | **2004  (restated  see Note 3)** | ** ** | **2003  (restated  see Note 3)** | ** ** |
| Current:                             |       |                                        |       |   |   |   |   |
| Federal                              |       | $                                           | 3,197      |   | $ | (2,109 | ) | $ | (1,880 | ) |
| State                                |       | 470                                         |       | (334 | ) | (340 | ) |
|                                 |       | 3,667                                       |       | (2,443 | ) | (2,220 | ) |
| Deferred:                            |       |                                        |       |   |   |   |   |
| Federal                              |       | (401                                        | )          | (3,997 | ) | (342 | ) |
| State                                |       | (40                                         | )          | (418 | ) | (36 | ) |
|                                 |       | (441                                        | )          | (4,415 | ) | (378 | ) |
| Total income tax benefit (provision) |       | $                                           | 3,226      |   | $ | (6,858 | ) | $ | (2,598 | ) |

 

66

----

Deferred income taxes include the net tax effects ofnet operating loss (“NOL”) carryforwards and the net tax effects of temporarydifferences between the carrying amounts of assets and liabilities and theamounts recorded for income tax purposes. The components of the deferred taxassets and liabilities are as follows as of December 31 (in thousands):

|                                       | ** ** | **2005  (restated  see Note 3)** | ** ** | **2004  (restated  see Note 3)** | ** ** |
|---------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| Deferred tax assets:                  |       |                                       |       |                                       |       |
| Allowance for  doubtful accounts      |       | $                                          | 600        |                                       | $          | 273 |   |
| Inventory  reduction of cost basis    |       | 2,643                                      |       | 146                                        |       |
| Sales return  allowance               |       | 352                                        |       | —                                     |       |
| Accrued warranty  liabilities         |       | 315                                        |       | 906                                        |       |
| Bid and proposal  costs               |       | 876                                        |       | 433                                        |       |
| Vacation accrual                      |       | 499                                        |       | 499                                        |       |
| Other reserves  and accruals          |       | 477                                        |       | 379                                        |       |
| Deferred revenue                      |       | 265                                        |       | 221                                        |       |
| Other                                 |       | 170                                        |       | 99                                         |       |
| Sale of  receivables                  |       | —                                     |       | 360                                        |       |
| Net operating losses  and tax credits |       | 927                                        |       | —                                     |       |
| Total deferred  tax assets            |       | 7,124                                      |       | 3,316                                      |       |
| Deferred tax  liabilities:            |       |                                       |       |                                       |       |
| Prepaid expenses  and other           |       | (268                                       | )          | —                                     |       |
| Sale of  receivables                  |       | (25                                        | )          |                                       |       |
| Depreciation and  amortization        |       | (2,901                                     | )          | (2,747                                     | )          |
| Total deferred  tax liabilities       |       | (3,194                                     | )          | (2,747                                     | )          |
| Valuation allowance                   |       | (3,930                                     | )          | —                                     |       |
| Net deferred tax assets               |       | $                                          | —     |                                       | $          | 569 |   |

 

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

The following is areconciliation of the statutory U.S. income tax rate to the Company’s effectivetax rate:

|                                             | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                  | ** ** | **2005  (restated  see Note 3)**  | ** ** | **2004  (restated  see Note 3)** | ** ** | **2003  (restated  see Note 3)** | ** ** |
| Statutory rate                              |       | (34.0                                       | )%         | 34.0 | % | 34.0 | % |
| State income taxes, net  of Federal benefit |       | (3.1                                        | )          | 3.6 |   | 4.0 |   |
| Other                                       |       | 0.8                                         |       | 1.5 |   | 1.6 |   |
| Tax contingency reserve                     |       | (1.4                                        | )          | 1.3 |   | 4.3 |   |
| Change in valuation  allowance              |       | 18.6                                        |       | — |   | — |   |
|                                        |       |                                        |       |   |   |   |   |
| Effective tax rate                          |       | (19.1                                       | )%         | 40.4 | % | 43.9 | % |

 

Asof December 31, 2005, the Company has net operating loss carryforwards ofapproximately $2.0 million for Federal income tax purposes which will expire in2025. Approximately $2.0 million of the NOL carryforward relates to stock basedcompensation expense for which subsequently recognized tax 

67

----

benefitswill be allocated to capital in excess of par value. The tax deduction benefitfrom the exercise of stock options of $0.3 million, $0.9 million, and $1.1million was recorded to capital in excess of par value for the years ended December 31,2005, 2004 and 2003, respectively.

**13.  401(k) Plan**

Effective April 1991, GTSI adopted the Employees’401(k) Investment Plan (the “Plan”), a savings and investment plan intended tobe qualified under Section 401 of the Internal Revenue Code of 1986, as amended(the “Code”). All employees of the Company who are at least 21 years of age areeligible to participate. The Plan is voluntary and allows participatingemployees to make pretax contributions, subject to limitations under the Code,of a percentage (not to exceed 30%) of their total compensation. Employeecontributions are fully vested at all times. GTSI matches employee contributions50% of the first five percent of eligible pay. In the years ended December 31,2005, 2004 and 2003, the Company contributed approximately $1.2 million, $1.0million and $1.0 million to the Plan, respectively.

**14.  Commitments and Contingencies**

*Product Warranties*

GTSI offersextended warranties on certain products for which GTSI is the primary obligorwhich are generally covered for three or five years beyond the warrantyprovided by the manufacturer. Products under extended warranty require repairor replacement of defective parts at no cost to the customer. The Companyrecords warranty liabilities at the time of sale for the estimated costs thatmay be incurred under its extended warranty contracts. The following tablesummarizes the activity related to product warranty liabilities for the yearsended December 31 (in thousands):

|                                            | ** ** | **2005  (restated  see Note 3)** | ** ** | **2004  (restated  see Note 3)** | ** ** |
|--------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| Accrued warranties at  beginning of year   |       | $                                          | 2,429      |                                       | $          | 4,555 |   |
| Charges made against  warranty liabilities |       | (1,316                                     | )          | (2,074                                     | )          |
| Adjustments to warranty  reserves          |       | (613                                       | )          | (1,659                                     | )          |
| Accruals for additional  warranties sold   |       | 349                                        |       | 1,607                                      |       |
| Accrued warranties at end of year          |       | $                                          | 849        |                                       | $          | 2,429 |   |

 

Revenue fromextended warranty contracts is recorded as deferred revenue and subsequentlyrecognized over the term of the contract. The following table summarizes theactivity related to the deferred warranty revenue for the years ended December 31(in thousands):

|                                                  | ** ** | **2005  (restated  see Note 3)** | ** ** | **2004  (restated  see Note 3)** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| 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 

68

----

options orrestrictions of the Company’s activities concerning dividends, additional debt,or further leasing. Rent expense for the years ended December 31, 2005,2004 and 2003 was approximately $2.7 million, $2.4 million and $2.5 million,respectively. Future minimum lease payments under operating leases that hadinitial or remaining non-cancelable lease terms in excess of one year as of December 31,2005 are as follows (in thousands):

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

 

*Contingencies*

In December 2004, the Company became aware that apotential payroll liability existed for employees working in GTSI’s office inGermany. Management determined that a tax liability was probable and accruedapproximately $0.8 million in estimated accrued liabilities. During the thirdquarter of 2005, the Company entered into a settlement agreement with theGerman tax authorities for $0.5 million and the remaining accrual of $0.3million was reversed and recorded as a reduction of selling, general andadministrative 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 as of December 31,2005 and $0.8 million as of December 31, 2004, as a security deposit forall tenant improvements associated with the lease.

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

*Employment Agreements*

The Company has an employment agreement with itsformer Chief Executive Officer which provides for payment of an amount equal tohis annual base salary plus bonus monies equal to the previous year’s bonuspayments upon termination of employment. In addition, the Company has change incontrol severance agreements covering 16 executives and key employees. Thesearrangements provide for payments of as much as 18 months of total targetcompensation and continuation of benefits upon the occurrence of specifiedevents. As of December 31, 2005, the Company did not believe it probablethat any of the specified events would occur. Accordingly, no accrual forseverance was recorded as of December 31, 2005. If information becomesknown to the Company at a later date which indicates severance of one or morecovered executives is probable, accruals for severance will be required (seeNote 16).

*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.

69

----

 

InNovember 2003, GTSI was served with a $25 million lawsuit, with treble damages,related to an alleged breach of contract due to the termination of Ichiban,Inc., a former subcontractor. This suit was filed in Virginia Circuit Court inFairfax County, Virginia and follows the Company’s earlier lawsuit against theformer subcontractor. The case was decided in the Company’s favor resulting inan award of $1.4 million in attorneys’ fees and costs. The plaintiff filedan appeal in October 2005 which the Supreme Court of Virginia refused onFebruary 17, 2006. The plaintiff has filed a Petition for a rehearing with theSupreme Court of Virginia.  In theopinion of management, resolution of this matter will not have a materialadverse effect upon the financial position or future operating results of theCompany.  The Company is aggressivelyworking to collect the awarded attorneys’ fees and costs from Ichiban; however,in accordance with SFAS No. 5, *Accounting forContingencies*, no amounts for this gain contingency were accrued asof December 31, 2005.

**15.  Segment Reporting**

GTSIengages in business activities as one operating segment that provides hardware,software and services primarily to the U. S. Federal Government.  The Company’s chief operating decision makerevaluates performance and determines resource allocation based on GTSI’sconsolidated sales and operating results. The following table summarizes the Company’s sales by type for the yearsended December 31 (in thousands):
| ** **                           | ** ** | **2005  (restated see   Note 3)** | ** ** | **2004  (restated  see Note 3)** | ** ** | **2003  (restated  see Note 3)** | ** ** |
|--------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| Hardware                             |       | $                                                | 706,686    |                                       | $          | 833,433                                    |       | $ | 689,936 |   |
| Software                             |       | 117,813                                          |       | 155,724                                    |       | 154,468                                    |       |
| Resold third-party  service products |       | 37,204                                           |       | 66,618                                     |       | 91,211                                     |       |
| Service                              |       | 20,309                                           |       | 19,662                                     |       | 15,896                                     |       |
| Total                                |       | $                                                | 882,012    |                                       | $          | 1,075,437                                  |       | $ | 951,511 |   |

 

*MajorCustomers*

Allof GTSI’s sales are earned from U.S. companies. Sales to multiple agencies anddepartments of the U.S. Federal Government, either directly or through primecontractors, accounted for approximately 92%, 95% and 97% of the Company’sconsolidated sales during the years ended December 31, 2005, 2004, and 2003,respectively.

**16.  Subsequent Events**

OnFebruary 13, 2006, the Company announced a further business alignment relatedto implementing its strategic plan to move GTSI into the solutions marketplace.In accordance with this plan, the Company eliminated duplication within theCompany and transitioned out of activities which have failed to yield adequateprofitability.

OnFebruary 16, 2006, the Company announced that the Board of Directors had namedJames J. Leto as the Company’s President and Chief Executive Officer effectiveimmediately. Mr. Leto has been a member of the Board of Directors since 1996and will retain his seat. In addition, former CEO and Chairman of the Board, M.Dendy Young, will maintain his position as Chairman of the Board. The Companyentered into a Transition Agreement on February 15, 2006 with Mr. Young inconnection with his resignation as CEO. This agreement terminates the terms ofthe Employment Agreement dated January 1, 2001 between the Company and M. DendyYoung and provides for a payment of $1.1 million over an 18-month period, aswell as reimbursement for certain benefits and legal fees. As a result of the 

70

----

Boardof Directors’ appointment of James J. Leto, the Company entered into anemployment agreement dated February 16, 2006.

On March 10, 2006, the Company and itslenders executed a forbearance agreement in respect of the Company’s CreditFacilities (the “Credit Agreement”) principally as the result of receiving anotice of default from its lenders during February 2006 related to the Company’sfinancial performance for the month ended January 31, 2006. Under the terms ofthe Credit Agreement, the Lenders agreed to forbear from exercising theirrights and remedies against GTSI in respect of certain existing defaults underthe Credit Facility and to continue to advance funds to the Company until May31, 2006, unless GTSI is in breach of the Credit Agreement at an earlier date.Under the Credit Agreement, in addition to its obligations under the CreditFacility, the Company agreed to:

·                  Provide increased access to its financialrecords to its lenders including daily borrowing base certificates; weekly cashflow projections and account collection activity for receivables greater than90 days; semi-monthly detailed accounts aging, inventory, and accounts payablereports; and

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

The Agreement included the following materialmodifications:

·                  Decreased the size of the Credit Facilityfrom $135 million to $75 million;

·                  During the period from March 10, 2006 to May31, 2006, suspended the application of the Maximum Total Funded Indebtedness toEBITDA and Minimum EBIT to Net Sales ratio covenants;

·                  Decreased the minimum tangible net worthrequirement from $60 million to $50 million;

·                  For the months of February, March, April andMay, 2006, added a Periodic Pre-Tax Loss requirement not to exceed $7.0million, $3.9 million, $4.3 million and $1.9 million, respectively; and

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

Asrequired by the Credit Agreement, the Company paid a $225,000 fee to theLenders.

OnApril 3, 2006, the Company defaulted on the covenant under the Credit Agreementwhen it received a staff determination letter from the NASDAQ National Marketstating that because GTSI has not filed its Annual Report on Form 10-K for 2005with the SEC, as required by Market Place Rule 4310(c)(14), GTSI’s common stockis subject to delisting from the NASDAQ National Market.  GTSI has requested a hearing with NASDAQwhich should stay the delisting pending the determination of NASDAQ’s hearingpanel.  While there is no assurance, theCompany expects to avoid delisting of its common stock from the NASDAQ NationalMarket by the filing of this Form 10-K for 2005 with the SEC before delistingwould otherwise take effect.

On April 10, 2006 the Company signed a commitment letter to negotiate anew revolving credit facility with two major money center banks by May 31,2006, the expiration date of the current Credit Facility. The Company and thelenders are working to complete their due diligence efforts and managementexpects to execute a new revolving credit facility agreement prior to June 1,2006.

**17.  Selected Quarterly FinancialData (unaudited)**

Thefollowing tables illustrate selected quarterly financial data for the two yearsended December 31, 2005. All quarters have been restated as described morecompletely in Note 3 of these consolidated financial statements.  GTSI has historically experienced significantseasonal fluctuations in its operations as a result of the U.S. FederalGovernment buying and funding patterns. Results of any one or more quarters arenot necessarily indicative of annual results or continuing trends.

71

----

 
| ** **                                                         | ** ** | **2005  (restated see Note 3)** | ** ** |
|--------------------------------------------------------------------|------------|------------------------------------------------|------------|
| **(in thousands, except per share data)** | ** ** | **Q1**                                         | ** ** | **Q2** | ** ** | **Q3** | ** ** | **Q4** | ** ** | **Total** | ** ** |
| Sales                                                              |       | $                                              | 156,629    |   | $ | 179,122 |   | $ | 267,449 |   | $ | 278,812 |   | $ | 882,012 |   |
| Gross margin (a)                                                   |       | $                                              | 17,393     |   | $ | 19,063 |   | $ | 35,901 |   | $ | 27,445 |   | $ | 99,802 |   |
| Net (loss)  income (c)                                             |       | $                                              | (6,244     | ) | $ | (5,538 | ) | $ | 2,967 |   | $ | (4,858 | ) | $ | (13,673 | ) |
|                                                               |       |                                           |       |   |   |   |   |   |   |   |   |
| Basic (loss)  earnings per share                                   |       | $                                              | (0.69      | ) | $ | (0.60 | ) | $ | 0.32 |   | $ | (0.52 | ) | $ | (1.49 | ) |
| Diluted (loss) earnings  per share                                 |       | $                                              | (0.69      | ) | $ | (0.60 | ) | $ | 0.31 |   | $ | (0.52 | ) | $ | (1.49 | ) |

 
| ** **                         | ** ** | **2004  (restated see Note 3)** | ** ** |
|------------------------------------|------------|------------------------------------------------|------------|
| ** **                         | ** ** | **Q1**                                         | ** ** | **Q2** | ** ** | **Q3** | ** ** | **Q4** | ** ** | **Total** | ** ** |
| Sales                              |       | $                                              | 177,784    |   | $ | 240,234 |   | $ | 322,942 |   | $ | 334,477 |   | $ | 1,075,437 |   |
| Gross margin (b)                   |       | 18,395                                         |       | 21,528 |   | 46,213 |   | $ | 35,956 |   | $ | 122,092 |   |
| Net (loss)  income                 |       | (1,643                                         | )          | (1,441 | ) | 10,145 |   | $ | 3,076 |   | $ | 10,135 |   |
|                               |       |                                           |       |   |   |   |   |   |   |   |   |
| Basic (loss)  earnings per share   |       | $                                              | (0.19      | ) | $ | (0.17 | ) | $ | 1.17 |   | $ | 0.35 |   | $ | 1.17 |   |
| Diluted (loss) earnings  per share |       | $                                              | (0.19      | ) | $ | (0.17 | ) | $ | 1.10 |   | $ | 0.33 |   | $ | 1.05 |   |

----

(a) Grossmargin for the year ended December 31, 2005 included a $5.6 million charge forexcess and obsolete inventory to write-down inventory to its market value asdiscussed in Note 7 of the consolidated financial statements. Gross margin wasreduced $1.6 million in Q2, $0.4 million in Q3 and $3.6 million in Q4 of 2005for this inventory impairment. This was offset in Q4 by the positive effects togross margin of $1.6 million due to a change in estimated payable to vendors.

(b) Grossmargin for the year ended December 31, 2004 included the positive effects ofthe derecognition of aged accounts payable of $10.1 million in Q3. In addition,gross margin reflects the positive impact of the change in estimated payable tovendors of $0.7 million in Q3 and $1.8 million in Q4. The total increase togross margin in the year ended December 31, 2004 for these items was $12.6million. See Note 1 to the consolidated financial statements for additionaldetails.

(c) DuringQ4, the Company recorded a valuation allowance against its net deferred taxasset, which increased net loss by $0.7 million.

72

----

Theadjustments to the previously reported consolidated statements of operations byquarter for 2005 and 2004 are presented below:
| ** **                                                         | ** ** | **2005  (restated see Note 3)** | ** ** |
|--------------------------------------------------------------------|------------|------------------------------------------------|------------|
| **(in thousands, except per share data)** | ** ** | **Q1(adjustments)**                            | ** ** | **Q2(adjustments)** | ** ** | **Q3(adjustments)** | ** ** | **Q4(adjustments)** | ** ** |
|                                                               |       |                                           |       |   |   |   |   |   |   |
| Sales                                                              |       | $                                              | (4,048     | ) | $ | 2,632 |   | $ | (2,412 | ) | $ | (423 | ) |
| Gross margin                                                       |       | $                                              | (1,080     | ) | $ | 3,159 |   | $ | 3,834 |   | $ | (1,028 | ) |
| Net (loss)  income                                                 |       | $                                              | (718       | ) | $ | 2,194 |   | $ | 90 |   | $ | 760 |   |
|                                                               |       |                                           |       |   |   |   |   |   |   |
| Basic (loss)  earnings per share                                   |       | $                                              | (0.08      | ) | $ | 0.24 |   | $ | 0.01 |   | $ | 0.09 |   |
| Diluted (loss) earnings  per share                                 |       | $                                              | (0.08      | ) | $ | 0.24 |   | $ | 0.01 |   | $ | 0.09 |   |

** **
| ** **                  | ** ** | **2004  (restated see Note 3)** | ** ** |
|-----------------------------|------------|------------------------------------------------|------------|
| ** **                  | ** ** | **Q1(adjustments)**                            | ** ** | **Q2(adjustments)** | ** ** | **Q3(adjustments)** | ** ** | **Q4(adjustments)** | ** ** |
| Sales                       |       | $                                              | (839       | ) | $ | 1,244 |   | $ | (7,703 | ) | $ | 6,587 |   |
| Gross margin                |       | $                                              | 313        |   | $ | (9 | ) | $ | (510 | ) | $ | 293 |   |
| Net income                  |       | $                                              | (262       | ) | $ | 112 |   | $ | (309 | ) | $ | 330 |   |
|                        |       |                                           |       |   |   |   |   |   |   |
| Basic earnings  per share   |       | $                                              | (0.03      | ) | $ | 0.01 |   | (0.04 | ) | $ | 0.04 |   |
| Diluted earnings per  share |       | $                                              | (0.03      | ) | $ | 0.01 |   | (0.03 | ) | $ | 0.04 |   |

 

 

73

----

** **

**ITEM 9.  CHANGES IN ANDDISAGREEMENTS WITH ACCOUNTANTS**

None.

 

**ITEM 9A.               CONTROLSAND PROCEDURES**

Anevaluation was carried out under the supervision and with the participation ofour management, including the Chief Executive Officer and Chief Financial Officer,of the effectiveness of the design and operation of our disclosure controls andprocedures, as defined in Rules 13a-15(e) or 15d-15(e) under the SecuritiesExchange Act of 1934, as amended, (the “Exchange Act”) as of December 31, 2005.Our disclosure controls and procedures are designed to (i) ensure thatinformation required to be disclosed by us in reports we file or submit underthe Exchange Act is recorded, processed, summarized and reported within thetime periods specified in the Securities and Exchange Commission’s rules andforms and (ii) is accumulated and communicated to GTSI’s management includingour principal executive officer and our principal financial officer, asappropriate to allow timely decisions regarding required disclosures. Based onthis evaluation, our Chief Executive Officer and Chief Financial Officerconcluded that, as a result of the material weaknesses set forth below, ourdisclosure controls and procedures were not effective as of December 31, 2005.

Aftermanagement concluded that there were material weaknesses, we performedadditional analyses and other post-closing procedures to ensure that ourconsolidated financial statements included in this Annual Report on Form 10-K/Awere prepared in accordance with generally accepted accounting principles andpresent fairly in all material respects our financial position, results ofoperations and cash flows for the periods presented.

Therewas no change in our internal control over financial reporting during ourfourth quarter of the year ended December 31, 2005 that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

**MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING**

**(asrevised)**

Ourmanagement is responsible for establishing and maintaining adequate internalcontrol over financial reporting as defined in Exchange Act Rules 13a-15(f) and15d-15(f). Under Section 404 of the Sarbanes-Oxley Act of 2002, our managementis required to assess the effectiveness of our internal control over financialreporting as of the end of the fiscal year and report, based on thatassessment, whether our internal control over financial reporting is effective.

Ourinternal control over financial reporting is a process designed to providereasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external reporting purposes inaccordance with U.S. generally accepted accounting principles (“GAAP”). Underthe supervision and with the participation of our management, including ourChief 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 criteria setforth in Internal Control—Integrated Framework established by the Committee ofSponsoring Organizations of the Treadway Commission (“COSO”).

Amaterial weakness, as defined under standards established by the Public CompanyAccounting Oversight Board’s Auditing Standard No. 2, is a control deficiency,or combination of control 

74

----

deficiencies,that results in more than a remote likelihood that a material misstatement ofannual or interim financial statements would not be prevented or detected.

Aspart of its year-end reporting and the preparation of the Annual Report on Form10-K for the year ended December 31, 2005, management concluded it wasnecessary to restate GTSI’s consolidated financial statements for the quartersended March 31, 2005, June 30, 2005 and September 30, 2005. Subsequent to thefiling of Form 10-K, management concluded further restatement of 2005, as wellas 2004 and 2003 was necessary (as further described in Note 3 of ourconsolidated financial statements) to correct the accounting for i) thetransfer of certain receivables to third parties under FAS 140; ii)overstatement of accounts payable and the related cost of sales; and iii) therecording of miscellaneous accounting adjustments appropriate for the fairpresentation of the financial statements.

Basedon management’s assessment of internal control over financial reporting as ofDecember 31, 2005 management initially concluded that GTSI’s internal controlover financial reporting was ineffective because of the following materialweaknesses:

**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 recognition for services, andincome taxes.  During our review of theinternal control environment, management determined that certain of thecontrols to be performed during the 2005 quarterly and year-end financial closeprocess had not been performed properly, which was due to turnover in three keyaccounting management positions during 2005 and also due to us not having sufficientresources to handle the new processes and procedures associated with GEMS,growth in our professional services business line, and increasinglysophisticated leasing transactions.

**Financial Close and ReportingProcess.** 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 businessmodel, we either lacked finance and accounting staff with the requisitequalifications and training to perform the quarterly and year-end financialclose and reporting process, or the closing procedures (including thesubsequent review and approval functions) were minimally or inadequatelydocumented or performed. The effect of these deficiencies was that adjustmentswere required to be recorded that had a material impact on net (loss) incomefor the interim periods in the year ended December 31, 2005. See Note 3 to ouraccompanying consolidated financial statements included in Part II, Item 8 ofthis Annual Report on Form 10-K/A. Due to the pervasiveness and the magnitudeof the errors in the areas noted above, management concluded that GTSI had amaterial weakness in its financial close and reporting process.

**Customer Order FulfillmentProcess.** Managementdetermined that GTSI had insufficient execution and oversight related to itscustomer order fulfillment process, which resulted in restatements to all theinterim periods in 2005 as well as material adjustments at year-end.  Specifically, GTSI recorded sales, cost ofsales, accounts receivable and accounts payable in the incorrect reportingperiods during 2005 due to a number of factors including inadequate training,inappropriate data entry, vendor payable reconciliations not being performed ona timely basis, and lack of oversight and communications between theappropriate departments.

75

----

These deficiencies were caused by, in part,our April 2005 implementation of the supply chain module of GEMS. Managementunder-estimated the impact the new system would have on the amount of time andresources needed to properly process customer order fulfillment transactions,and did not modify our customer order fulfillment process to accommodatechanged system capabilities.

Due to the pervasiveness and the magnitude ofthe errors in the areas noted above, management concluded that GTSI had amaterial weakness in its customer order fulfillment process.

Subsequentto our initial assessment of internal control over financial reporting,management identified two additional material weaknesses.

**Accounts Receivable Process**. Management determined that GTSI hadinsufficient controls over the transfer of receivables to third parties whichresulted in inaccurate accounting. This deficiency was exacerbated by thefinance and accounting staffing material weakness noted above and theincreasingly sophisticated leasing transactions occurring. GTSI’s accountingdepartment lacked the depth, training and experience to research and apply thecomplex accounting requirements prescribed in FAS 140. As a result, all receivablestransferred to third parties were accounted for as sales, the receivables wereremoved from the balance sheet and gains on the sales were recorded in full atthe time of transfer as other income. During 2006, management concluded thatthe repurchase provisions in some agreements precluded sales treatment;therefore, the receivables should have remained on GTSI’s balance sheets.

GTSI’s lack of sufficient internal controlsin this process resulted in material understatements of accounts receivable andrelated liabilities in its 2005, 2004 and 2003 balance sheets. Furthermore,significant prior period adjustments were necessary as part of the Company’srestatement efforts to recognize income over the life of the lease rather thanat the time of transfer.

Due to the magnitude of the errors inaccounts receivable, lease receivables, financing receivables, financed leasedebt, lease related income and interest expense, management concluded inOctober 2006 that GTSI had an additional material weakness in internal controlover financial reporting in its accounts receivable process.

**Accounts Payable Process.**Management determined that GTSI, as ofDecember 31, 2005 and for a period of time prior to that date, had insufficientoversight of its accounts payable process, which resulted in restatements toall the interim periods during 2005, 2004 and 2003. We either lacked sufficientfinance and accounting staff to perform monthly reconciliations of all accountspayable balances, or the subsequent reviews of reconciliations wereineffective. As a result, overstatements of cost of sales and certain accountspayable accounts occurred. Due to the materiality of these overstatements,management concluded that GTSI had a material weakness in its accounts payableprocess.

Managementconcluded it was necessary to record prior period adjustments during the yearsended December 31, 2005, 2004 and 2003 to record receivables transferred tothird parties in accordance with FAS 140 and correctly state cost of sales andcertain accounts payable accounts. We corrected all material errors discoveredduring the restatement of our interim and annual financial statements during2005, 2004 and 2003. Therefore, we are restating our previously reported annualresults as of December 31, 2005, 2004 and 2003, as well as the quarterlyresults for each of the quarters ended during 2005 and 2004, in this AnnualReport on Form 10-K/A. Until these deficiencies are remediated, there is morethan a remote likelihood that a material misstatement to the annual or interimconsolidated financial statements could occur and not be prevented or detectedby our controls in a timely manner.

76

----

Becauseof the material weaknesses described above, we have concluded that GTSI did notmaintain effective internal control over financial reporting as of December 31,2005 based on the criteria in the Internal Control-Integrated Framework.

Management’s assessment ofthe effectiveness of internal control over financial reporting as of December31, 2005 has been audited by Ernst & Young LLP, an independent registeredpublic accounting firm. Their report appears below.

**REMEDIATIONOF MATERIAL WEAKNESSES**

Managementis required to ensure that its personnel throughout all areas of the companyhave the competence, resources, training, and supervision; that policies andprocedures necessary for their assigned levels of responsibility are in place;and that sufficient staff is present to effectively perform all processesnecessary to maintaining a proper internal control environment. Management isalso responsible for maintaining effective internal control processes over itsfinancial close and reporting process.

Inorder to remediate the aforementioned material weaknesses, management is takingthe following actions:

i.                  Increasing the size, expertise and trainingof the finance and accounting staff to include adequate resources for ensuringGAAP compliance in revenue recognition for multiple-element arrangements,leasing and professional service transactions, transfers of financial assets,and the related accounting.

ii.               Enhancingour accounting process and procedures for accounting for the transfers ofreceivables to third parties.

iii.            Upgradingthe capabilities of certain staff in existing finance and accounting positionsto ensure that our professionals possess sufficient GAAP knowledge andexperience necessary not only to perform their assigned tasks, but also tounderstand how those tasks are related to others within GTSI and to improve theoverall quality and integrity of record keeping and financial reporting.

iv.           Enhancingthe accounting policies and procedures to provide adequate, sufficient, anduseful guidance to staff such that adherence to them should result in higherdegrees of assurance of accurate and complete financial reporting.

v.              Implementing a more rigorous accountreconciliation and account aging review and approval process on a quarterlybasis, particularly in the accounts receivable and accounts payable areas.

vi.           Improvingthe quarterly 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.

vii.        Improvingthe information 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.

viii.     Ensuringthat the purchasing, 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.

ix.             Re-engineering the fulfillment of customerorders process through a number of initiatives, including increased use ofautomation to capture and record information critical for ensuring properaccounting treatment of the underlying transactions.

We primarily began these remediation stepssubsequent to December 31, 2005 and expect to finalize them by mid-2007.

77

----

TheAudit Committee of the Board of Directors has been actively involved with ourassessment of our internal controls environment and the above material weaknessconclusions.  They are being continuallyupdated as to our remediation progress, and we would expect this communicationto continue until all control deficiency issues are addressed and remediated totheir satisfaction.

Report of Ernst & YoungLLP,

Independent RegisteredPublic Accounting Firm,

on Internal Control over Financial Reporting

Tothe Board of Directors and Stockholders of GTSI Corp

Wehave audited management’s assessment, included in the accompanying Management’sReport on Internal Control Over Financial Reporting, that GTSI Corp. did notmaintain effective internal control over financial reporting as of December 31,2005, because of the effect of certain material weaknesses described below,based on criteria established in Internal Control—Integrated Framework issuedby the Committee of Sponsoring Organizations of the Treadway Commission (the“COSO criteria”). GTSI Corp.’s management is responsible for maintainingeffective internal control over financial reporting and for its assessment ofthe effectiveness of internal control over financial reporting. Ourresponsibility is to express an opinion on management’s assessment and anopinion on the effectiveness of GTSI Corp.’s internal control over financialreporting based on our audit.

Weconducted our audit in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in allmaterial respects. Our audit included obtaining an understanding of internalcontrol over financial reporting, evaluating management’s assessment, testingand evaluating the design and operating effectiveness of internal control, andperforming such other procedures as we considered necessary in thecircumstances. We believe that our audit provides a reasonable basis for ouropinion.

Acompany’s internal control over financial reporting is a process designed toprovide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordancewith generally accepted accounting principles. A company’s internal controlover financial reporting includes those policies and procedures that (1)pertain to the maintenance of records that, in reasonable detail, accuratelyand fairly reflect the transactions and dispositions of the assets of thecompany; (2) provide reasonable assurance that transactions are recorded asnecessary to permit preparation of financial statements in accordance withgenerally accepted accounting principles, and that receipts and expenditures ofthe company are being made only in accordance with authorizations of managementand directors of the company; and (3) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use, or dispositionof the company’s assets that could have a material effect on the financialstatements.

Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements. Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

Amaterial weakness is a control deficiency, or combination of controldeficiencies, that results in more than a remote likelihood that a materialmisstatement of the annual or interim financial statements will not beprevented or detected. The following material weaknesses have been identified andincluded in management’s assessment:

78

----

·                  GTSI as of December 31, 2005and for a period of time prior to that date, had an insufficient number offinance and accounting staff and some of the Company’s finance and accountingstaff lacked sufficient training and expertise in areas such as accounting forleasing transactions, revenue recognition for services, and income taxes.

·                  GTSI had insufficientcontrols over the quarterly and year-end financial close and reporting process.This deficiency was exacerbated by the finance and accounting staffing materialweakness as noted above, and was manifested primarily in control deficienciesin the accounting for inventory valuation, customer returns, revenuerecognition (including leasing and professional services transactions),accruals and the tax provision, all which required post-closing adjustments toinventory, accounts payable, accounts receivable, accrued liabilities, sales,cost of sales and taxes in the fourth quarter of 2005.

·                  GTSI had insufficient execution and oversightrelated to its customer order fulfillment process during 2005, which resultedin restatements to all the interim periods in 2005 as well as adjustments atyear-end. Specifically, the Company erroneously recorded sales, cost of goodssold, accounts receivable and accounts payable in incorrect reporting periodsduring 2005 due to a number of factors including inadequate training,inappropriate data entry, vendor payable reconciliations not being performed ona timely basis, lack of oversight and communication within the appropriatedepartments, and significant employee and management turnover within many ofthe impacted areas.

The combination of theabove factors resulted in errors in the preparation of the 2005 interim andannual financial statements in the areas of inventory valuation, accountspayable, accounts receivable, sales, and cost of sales, and resulted in anumber of post-closing adjustments to the Company’s consolidated financialstatements as of and for the year ended December 31, 2005 and restatement ofits interim financial statements for the quarters ended March 31, 2005, June30, 2005 and September 30, 2005.

Inour previous report dated April 10, 2006, we expressed an unqualified opinionon management’s previous assessment that the Company did not maintain effectiveinternal control over financial reporting as of December 31, 2005 and anadverse opinion on the effectiveness of internal control over financialreporting as of December 31, 2005 because of the effect of material weaknessesdescribed in management’s previous report on internal control over financialreporting. Management has subsequently determined that additional materialweaknesses existed as of December 31, 2005. As a result, management has revisedits assessment, as presented in the accompanying Management’s Report onInternal Control over Financial Reporting, to include these additional materialweaknesses. Accordingly, we have revised our previously issued annual report oninternal control over financial reporting to include descriptions of theseadditional material weaknesses.

Theadditional weaknesses identified by management and included in management’sassessment include:

·                  As of December 31, 2005 and for a period oftime prior to that, management had insufficient controls over the accountingfor the transfer of receivables to third parties.  This resulted in inaccurate accounting. Thisdeficiency was exacerbated by the finance and accounting staffing materialweakness noted above and the increasing level of sophisticated leasingtransactions. GTSI’s accounting department lacked the training and experienceto research and apply the complex accounting requirements prescribed in FAS140.

·                  As of December 31, 2005 and for a period oftime prior to that date, GTSI had insufficient oversight of its accountspayable process, which resulted in restatements to all periods during 2005,2004 and 2003. The Company lacked sufficient finance and accounting staff toperform monthly reconciliations of all accounts payable balances.

79

----

Thecombination of these additional material weaknesses resulted in errors in thepreparation of the 2005, 2004 and 2003 interim and annual financial statementsin the areas of lease transactions and related transfers of receivables,inventory valuation, accounts payable, accounts receivable, sales, and cost ofsales, and required restatement of the Company’s consolidated financialstatements as of and for the year ended December 31, 2005, 2004 and 2003 andrestatement of interim financial statements for the first quarter ended March31, 2006. 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 accordingly this report does not affect our reportdated April 10, 2006 (except for Notes 3, 5 and 6, as to which the date isDecember 21, 2006) on those financial statements.

Inour opinion, management’s assessment that GTSI Corp. did not maintain effectiveinternal control over financial reporting as of December 31, 2005, is fairlystated, in all material respects, based on the COSO control criteria. Also, inour opinion, because of the effect of the material weaknesses described aboveon the achievement of the objectives of the control criteria, GTSI Corp. didnot maintain effective internal control over financial reporting as of December31, 2005, based on the COSO control criteria.

/s/ Ernst & Young LLP

McLean, Virginia

April10, 2006 (except for the effects of the material weaknesses described in the eighthand ninth paragraphs above, as to which the date is December 31, 2006)

**ITEM 9B.               OTHERINFORMATION**

None.

80

----

**PART III**
| **ITEM 10.** | ** ** | **DIRECTORS AND EXECUTIVE OFFICERS OF THE  REGISTRANT** |
|--------------|------------|---------------------------------------------------------|

 

The information required by this Item is incorporated by reference tothe sections of the Registrant’s definitive Proxy Statement for the AnnualMeeting of Stockholders scheduled to be held on May 9, 2006 (the “Proxy Statement”) entitled “Proposal1 - Election of Directors,” “Continuing Directors,” “Executive Officers,” “Boardof Directors, Committees and Corporate Governance,” “Code of Ethics,” “CertainRelationships and 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.** | ** ** | **EXECUTIVE COMPENSATION** |
|--------------|------------|----------------------------|

 

The information required by this Item is incorporated by reference tothe sections of the Proxy Statement entitled “Executive Compensation and OtherInformation,” “Compensation of Directors,” “Employment Agreements andTermination of Employment and Change of Control Arrangements,” “PerformanceGraph” and “Compensation Committee Report on Executive Compensation.”
| **ITEM 12.** | ** ** | **SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS  AND MANAGEMENT** |
|--------------|------------|---------------------------------------------------------------------|

 

The information regarding the security ownership of certain beneficialowners and management required by this Item is incorporated by reference to thesection of the Proxy Statement entitled “Common Stock Ownership of PrincipalStockholders and Management.”

The information required by Item 201(d) of Regulation S-K is providedunder Item 5, Market for Registrants Common Equity, Related Stockholder Mattersand Issuer Purchases of Equity Securities, which is incorporated herein byreference.
| **ITEM 13.** | ** ** | **CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS** |
|--------------|------------|----------------------------------------------------|

 

The information required by this Item is incorporated by reference tothe section of the Proxy Statement entitled “Certain Relationships and RelatedTransactions.”
| **ITEM 14.** | ** ** | **PRINCIPAL ACCOUNTING FEES AND SERVICES** |
|--------------|------------|--------------------------------------------|

 

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

81

----

**PART IV**
| **ITEM  15.** | ** ** | **EXHIBITS,  FINANCIAL STATEMENTS AND SCHEDULES, AND REPORTS ON FORM 8-K:**                                                                                            |
|--------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **         | ** ** | ** **                                                                                                                                                             |
| **(a)**            | ** ** | **Financial Statements**                                                                                                                                               |
| ** **         | ** ** | ** **                                                                                                                                                             |
| ** **         | ** ** | The consolidated financial  statements of GTSI Corp. filed are as follows:                                                                                             |
| ** **         | ** ** | Consolidated Balance Sheets as of December 31, 2005 and 2004                                                                                                           |
| ** **         | ** ** | Consolidated Statement of Operations for each of the three years in  the periodended December 31, 2005                                                                 |
| ** **         | ** ** | Consolidated Statements of Changes in Stockholders’ Equity for each  of thethree years in the period  ended December 31, 2005                                     |
| ** **         | ** ** | Consolidated Statements of Cash Flows for each of the three years in  the periodended December 31, 2005                                                                |
| ** **         | ** ** | Notes to Consolidated Financial Statements                                                                                                                             |
| ** **         | ** ** | ** **                                                                                                                                                             |
| ** **         | ** ** | **Financial Statement  Schedules**                                                                                                                                     |
| ** **         | ** ** | ** **                                                                                                                                                             |
| ** **         | ** ** | The financial statement  schedules of GTSI Corp. and subsidiaries filed are as follows:                                                                                |
| ** **         | ** ** | Schedule II — Valuation and Qualifying Accounts for each of the three  years inthe period ended December 31,  2005                                                |
| ** **         | ** ** |                                                                                                                                                                   |
| ** **         | ** ** | All other schedules are  omitted because they are not applicable, or the required information is shown  in the consolidated financial statements or the notes thereto. |
| ** **         | ** ** | ** **                                                                                                                                                             |
| ** **         | ** ** | **Exhibits**                                                                                                                                                           |
| ** **         | ** ** | ** **                                                                                                                                                             |
| ** **         | ** ** | The exhibits set forth in  the Exhibit Index are filed as part of this Annual Report on Form 10-K/A.                                                                   |

 

82

----

**SIGNATURES**

Pursuantto the requirements of Section 13 or 15 (d) of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on December 22,2006 on its behalf by the undersigned thereunto duly authorized.

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

 

Pursuant to the requirements of the Securities Exchange Act of 1934,this report has been signed on December 22, 2006 by the following persons onbehalf of the registrant and in the capacities indicated.
| /s/ JAMES J. LETO                                                                                        |   |   |
|----------------------------------------------------------------------------------------------------------|--------|--------|
| James J. LetoPresident, Chief Executive  Officer, and Director(Principal Executive Officer)              |   |   |
|                                                                                                     |   |   |
| /s/ JOE RAGAN                                                                                            |   |   |
| Joe RaganSenior Vice President and  Chief Financial Officer(Principal Financial and Accounting  Officer) |   |   |

 

83

----

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

**SCHEDULEII**
| ** **                                             | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                             | ** ** | **2005  (restated  see Note 3)**  | ** ** | **2004** | ** ** | **2003** | ** ** |
| Allowance for Doubtful  Accounts                       |       |                                        |       |   |   |   |   |
| Balance at  beginning of period                        |       | $                                           | 1,009      |   | $ | 699 |   | $ | 834 |   |
| Additions — charged  to expense or other accounts |       | 1,410                                       |       | 507 |   | 57 |   |
| Deductions                                             |       | (451                                        | )          | (197 | ) | (192 | ) |
| Balance at end  of period                              |       | $                                           | 1,968      |   | $ | 1,009 |   | $ | 699 |   |
|                                                   |       |                                        |       |   |   |   |   |
| Sales Returns  Allowance(1)                            |       |                                        |       |   |   |   |   |
| Balance at  beginning of period                        |       | $                                           | —     |   | $ | — |   | $ | — |   |
| Additions —  charged to expense or other accounts |       | 9,903                                       |       | — |   | — |   |
| Deductions                                             |       | (1,787                                      | )          | — |   | — |   |
| Balance at end  of period                              |       | $                                           | 8,116      |   | $ | — |   | $ | — |   |
|                                                   |       |                                        |       |   |   |   |   |
| Deferred Tax Asset  Valuation Allowance                |       |                                        |       |   |   |   |   |
| Balance at  beginning of period                        |       | $                                           | —     |   | $ | — |   | $ | — |   |
| Additions —  charged to expense or other accounts |       | 3,930                                       |       | — |   | — |   |
| Deductions                                             |       | —                                      |       | — |   | — |   |
| Balance at end  of period                              |       | $                                           | 3,930      |   | $ | — |   | $ | — |   |

----

(1)             Thesales returns allowance is reported as a reduction of accounts receivable onthe consolidated balance sheets.

Allother schedules are omitted since the required information is not present or isnot present in amount sufficient to require submission of the schedule, orbecause the information is included in the consolidated financial statements ornotes thereto.

84

----

**EXHIBIT INDEX**
| 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)                                                                                                                                                     |       |

----

*                    Managementcontracts and compensatory plans and arrangements required to be filed pursuantto Item 15 (c).

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

85

----

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

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

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

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

(6)             Incorporated byreference to the Registrant’s Annual Report on Form 10-K for the year endedDecember 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 the year endedDecember 31, 2004.

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

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

(11)       Incorporated by referenceto the Registrant’s Quarterly Report on Form 10-Q/A for the period ended June30, 2005.

(12)       Incorporated by referenceto Appendix A of the Registrant’s 2005 Proxy Statement.

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

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

(15)       Incorporated by referenceto the Registrant’s Current Report on Form 8-K dated December 27, 2005.

(16)       Incorporated by referenceto the Registrant’s Current Report on Form 8-K/A dated March 10, 2006.

 

86

----