**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

** **

**FORM 10-Q**

** **

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

 

**For the quarterly period ended June 30, 2006**

** **

**Commission File Number:     0-19394**

** **

**GTSI Corp.**

(Exact name of registrant 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)

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 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 o   Acceleratedfiler  x   Non-accelerated filer o

The number of shares of common stock, $0.005 par value, outstanding asof September 30, 2006 was 9,484,723.

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

 

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**GTSI CORP.Form 10-Q for the Quarter Ended June 30, 2006**

**INDEX**
|                                          | ** ** | ** **                                                                                                                         | ** ** | **Page** |
|------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------|------------|----------|
| **PART  I — FINANCIAL INFORMATION** |       |                                                                                                                               |
| ** **                               |       |                                                                                                                               |
| ITEM  1.                                 |       | FINANCIAL  STATEMENTS —                                                                                                       |       |     |
|                                     |       |                                                                                                                               |       |     |
|                                     |       | Condensed Consolidated Balance Sheets as of June 30,  2006 (Unaudited) and December 31, 2005                                  |       | 2        |
|                                     |       |                                                                                                                               |       |     |
|                                     |       | Condensed Consolidated Statements of Operations for  the Three and Six Months  Ended  June 30, 2006 and 2005 (Unaudited) |       | 3        |
|                                     |       |                                                                                                                               |       |     |
|                                     |       | Condensed Consolidated Statements of Cash Flows for  the Six Months Ended June 30, 2006 and 2005 (Unaudited)                  |       | 4        |
|                                     |       |                                                                                                                               |       |     |
|                                     |       | Notes to Condensed Consolidated Financial Statements  (Unaudited)                                                                  |       | 5        |
|                                     |       |                                                                                                                               |       |     |
| ITEM 2.                                  |       | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL  CONDITION AND RESULTS OF OPERATIONS                                   |       | 15       |
|                                     |       |                                                                                                                               |       |     |
| ITEM 3.                                  |       | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET  RISK                                                                        |       | 24       |
|                                     |       |                                                                                                                               |       |     |
| ITEM 4.                                  |       | CONTROLS AND PROCEDURES                                                                                                            |       | 25       |
|                                     |       |                                                                                                                               |       |     |
| **PART  II — OTHER INFORMATION**    |       |                                                                                                                               |
| ** **                               |       |                                                                                                                               |
| ITEM 4.                                  |       | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                                                |       | 26       |
| ** **                               |       |                                                                                                                               |       |     |
| ITEM 6.                                  |       | EXHIBITS                                                                                                                           |       | 26       |
|                                     |       |                                                                                                                               |       |     |
| **SIGNATURES**                           |       | 26                                                                                                                                 |
| ** **                               |       | ** **                                                                                                                         |       |     |
| **EXHIBIT INDEX**                        |       | 27                                                                                                                                 |

 

1

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**PART I.FINANCIAL INFORMATION**

###### **Item 1.  FinancialStatements**

**GTSI CORP.CONDENSED CONSOLIDATED BALANCE SHEETS**(In thousands, exceptshare and per share data)
| ** **                                                                                                                                                                                              | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                              | ** ** | **(Unaudited)**         | ** ** | **(restated see**      | ** ** |
| ** **                                                                                                                                                                                              | ** ** | ** **              | ** ** | **Note 3)**            | ** ** |
| **ASSETS**                                                                                                                                                                                              | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Current assets:                                                                                                                                                                                         | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Cash                                                                                                                                                                                                    |       | $                       | 25         |                        | $          | 27 |   |
| Accounts  receivable, net                                                                                                                                                                               |       | 154,197                 |       | 226,356                     |       |
| Inventory                                                                                                                                                                                               |       | 51,598                  |       | 56,819                      |       |
| Deferred costs                                                                                                                                                                                          |       | 16,613                  |       | 17,069                      |       |
| Other current  assets                                                                                                                                                                                   |       | 22,069                  |       | 8,605                       |       |
| Total current  assets                                                                                                                                                                                   |       | 244,502                 |       | 308,876                     |       |
| Depreciable  assets, net                                                                                                                                                                                |       | 12,789                  |       | 13,640                      |       |
| Long-term  financing receivables and other assets                                                                                                                                                       |       | 27,342                  |       | 23,391                      |       |
| Total assets                                                                                                                                                                                            |       | $                       | 284,633    |                        | $          | 345,907 |   |
|                                                                                                                                                                                                    |       |                    |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                                                          |       |                    |       |                        |       |
| Current liabilities:                                                                                                                                                                                    |       |                    |       |                        |       |
| Borrowings under  credit agreement                                                                                                                                                                      |       | $                       | 1,270      |                        | $          | 48,014 |   |
| Accounts payable                                                                                                                                                                                        |       | 131,703                 |       | 151,995                     |       |
| Financed lease  debt                                                                                                                                                                                    |       | 30,610                  |       | 25,187                      |       |
| Accrued  liabilities                                                                                                                                                                                    |       | 18,160                  |       | 16,603                      |       |
| Deferred revenue                                                                                                                                                                                        |       | 4,899                   |       | 6,020                       |       |
| Accrued warranty  liabilities                                                                                                                                                                           |       | 843                     |       | 849                         |       |
| Total current  liabilities                                                                                                                                                                              |       | 187,485                 |       | 248,668                     |       |
| Long-term debt                                                                                                                                                                                          |       | 10,000                  |       | —                      |       |
| Long-term financed  lease debt                                                                                                                                                                          |       | 14,121                  |       | 15,996                      |       |
| Other  liabilities                                                                                                                                                                                      |       | 2,994                   |       | 3,076                       |       |
| Total  liabilities                                                                                                                                                                                      |       | 214,600                 |       | 267,740                     |       |
|                                                                                                                                                                                                    |       |                    |       |                        |       |
| Commitments and  contingencies                                                                                                                                                                          |       |                    |       |                        |       |
|                                                                                                                                                                                                    |       |                    |       |                        |       |
| Stockholders’ equity                                                                                                                                                                               |       |                    |       |                        |       |
| Common stock -  $0.005 par value, 20,000,000 shares authorized; 9,806,084 issued and  9,390,059 outstanding at June 30, 2006; and 9,806,084 issued and 9,307,606  outstanding at December 31, 2005 |       | 49                      |       | 49                          |       |
| Capital in  excess of par value                                                                                                                                                                         |       | 45,438                  |       | 45,104                      |       |
| Retained  earnings                                                                                                                                                                                      |       | 27,648                  |       | 36,731                      |       |
| Treasury stock,  416,025 shares at June 30, 2006 and 498,478 shares at December 31, 2005,  at cost                                                                                                 |       | (3,102                  | )          | (3,717                      | )          |
| Total  stockholders’ equity                                                                                                                                                                        |       | 70,033                  |       | 78,167                      |       |
| Total liabilities and  stockholders’ equity                                                                                                                                                        |       | $                       | 284,633    |                        | $          | 345,907 |   |

 

Theaccompanying notes are an integral part of these condensed consolidatedfinancial statements.

2

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**GTSI CORP.CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**(Unaudited)(In thousands, except per sharedata)
| ** **                                      | ** ** | **Three months ended** | ** ** | **Six months ended**       | ** ** |
|-------------------------------------------------|------------|----------------------------------|------------|--------------------------------------|------------|
| ** **                                      | ** ** | **June 30,**                | ** ** | **June 30,**                    | ** ** |
| ** **                                      | ** ** | **2006**                         | ** ** | **2005**                             | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                      | ** ** | ** **                       | ** ** | **(restated see  Note 3)** | ** ** | ** ** | ** ** | **(restated see  Note 3)** | ** ** |
|                                            |       |                             |       |                                 |       |   |   |   |   |
| SALES                                           |       | $                                | 180,956    |                                 | $          | 179,122 |   | $ | 329,236 |   | $ | 335,751 |   |
|                                            |       |                             |       |                                 |       |   |   |   |   |
| COST OF SALES                                   |       | 154,446                          |       | 160,059                              |       | 284,424 |   | 299,295 |   |
|                                            |       |                             |       |                                 |       |   |   |   |   |
| GROSS MARGIN                                    |       | 26,510                           |       | 19,063                               |       | 44,812 |   | 36,456 |   |
|                                            |       |                             |       |                                 |       |   |   |   |   |
| SELLING, GENERAL  & ADMINISTRATIVE EXPENSES |       | 27,118                           |       | 28,420                               |       | 56,723 |   | 56,524 |   |
|                                            |       |                             |       |                                 |       |   |   |   |   |
| LOSS FROM  OPERATIONS                           |       | (608                             | )          | (9,357                               | )          | (11,911 | ) | (20,068 | ) |
|                                            |       |                             |       |                                 |       |   |   |   |   |
| INTEREST AND  OTHER INCOME                      |       |                             |       |                                 |       |   |   |   |   |
| Lease-related income                            |       | 2,602                            |       | 617                                  |       | 4,980 |   | 1,450 |   |
| Interest and other income                       |       | 587                              |       | 213                                  |       | 865 |   | 403 |   |
| Interest and other expense                      |       | (1,637                           | )          | (370                                 | )          | (3,017 | ) | (700 | ) |
| Interest and other income, net                  |       | 1,552                            |       | 460                                  |       | 2,828 |   | 1,153 |   |
|                                            |       |                             |       |                                 |       |   |   |   |   |
| INCOME (LOSS)  BEFORE INCOME TAXES              |       | 944                              |       | (8,897                               | )          | (9,083 | ) | (18,915 | ) |
|                                            |       |                             |       |                                 |       |   |   |   |   |
| INCOME TAX  BENEFIT                             |       | —                           |       | 3,359                                |       | — |   | 7,133 |   |
|                                            |       |                             |       |                                 |       |   |   |   |   |
| NET INCOME (LOSS)                               |       | $                                | 944        |                                 | $          | (5,538 | ) | $ | (9,083 | ) | $ | (11,782 | ) |
|                                            |       |                             |       |                                 |       |   |   |   |   |
| EARNINGS (LOSS)  PER SHARE                      |       |                             |       |                                 |       |   |   |   |   |
| Basic                                           |       | $                                | 0.10       |                                 | $          | (0.60 | ) | $ | (0.97 | ) | $ | (1.29 | ) |
| Diluted                                         |       | $                                | 0.10       |                                 | $          | (0.60 | ) | $ | (0.97 | ) | $ | (1.29 | ) |
|                                            |       |                             |       |                                 |       |   |   |   |   |
| WEIGHTED AVERAGE  SHARES OUTSTANDING            |       |                             |       |                                 |       |   |   |   |   |
| Basic                                           |       | 9,348                            |       | 9,243                                |       | 9,331 |   | 9,123 |   |
| Diluted                                         |       | 9,465                            |       | 9,243                                |       | 9,331 |   | 9,123 |   |

 

Theaccompanying notes are an integral part of these condensed consolidatedfinancial statements.

3

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**GTSI CORP.CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**(Unaudited)(In thousands)
| ** **                                                                      | ** ** | **Six months ended** | ** ** |
|---------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                      | ** ** | **June 30,**              | ** ** |
| ** **                                                                      | ** ** | **2006**                       | ** ** | **2005** | ** ** |
| ** **                                                                      | ** ** | ** **                     | ** ** | **(restated  see Note 3)** | ** ** |
| ** **                                                                      | ** ** | ** **                     | ** ** | ** ** | ** ** |
| **CASH  FLOWS FROM OPERATING ACTIVITIES:**                                      |       |                           |       |   |   |
| Net loss                                                                        |       | $                              | (9,083     | ) | $ | (11,782 | ) |
| Adjustments to  reconcile net loss to net cash provided by operating activities |       | 32,835                         |       | 2,927 |   |
| Net cash provided by (used in) operating activities                             |       | 23,752                         |       | (8,855 | ) |
|                                                                            |       |                           |       |   |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES:**                                      | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Purchase of  depreciable assets                                                 |       | (1,293                         | )          | (2,204 | ) |
| Net cash used in investing activities                                           |       | (1,293                         | )          | (2,204 | ) |
|                                                                            |       |                           |       |   |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                                      | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Payments on  credit agreement                                                   |       | (46,744                        | )          | (1,116 | ) |
| Proceed from  financed lease debt                                               |       | 13,978                         |       | 11,259 |   |
| Proceeds from long-term  debt                                                   |       | 10,000                         |       | — |   |
| Payments to  acquire treasury stock                                             |       | —                         |       | (1,333 | ) |
| Proceeds from  ESPP                                                             |       | 95                             |       | 246 |   |
| Proceeds from  exercises of stock options                                       |       | 210                            |       | 1,910 |   |
| Net cash (used in) provided by financing activities                             |       | (22,461                        | )          | 10,966 |   |
|                                                                            |       |                           |       |   |   |
| NET DECREASE IN  CASH                                                           |       | (2                             | )          | (93 | ) |
|                                                                            |       |                           |       |   |   |
| CASH AT  BEGINNING OF PERIOD                                                    |       | 27                             |       | 387 |   |
|                                                                            |       |                           |       |   |   |
| CASH AT END OF PERIOD                                                           |       | $                              | 25         |   | $ | 294 |   |

 

Theaccompanying notes are an integral part of these condensed consolidatedfinancial statements.

4

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**GTSI CORP.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**(Unaudited)

**1.  Basis of Presentation**

Theaccompanying unaudited interim condensed consolidated financial statements ofGTSI Corp. and its subsidiaries (“GTSI” or the “Company”) have been preparedpursuant to the rules and regulations of the Securities and Exchange Commissionfor quarterly reports on Form 10-Q and, therefore, omit or condense certainnote disclosures and other information required by U.S. generally acceptedaccounting principles for complete financial statements.  These financial statements should thereforebe read in conjunction with the audited consolidated financial statements andaccompanying notes for the year ended December 31, 2005 included in GTSI’sAnnual Report on Form 10-K/A.

Inthe opinion of management, the accompanying unaudited condensed consolidatedfinancial statements reflect all adjustments of a normal recurring nature(except as disclosed herein) considered necessary to present fairly GTSI’sfinancial position as of June 30, 2006 and its results of operations and cashflows for the three and six month periods ended June 30, 2006.

Theresults of operations for the three and six month periods ended June 30, 2006are not necessarily indicative of the results that may be expected for the fullyear, or future periods.  GTSI hashistorically experienced significant seasonal fluctuations in operations as aresult of government buying and funding patterns.  These patterns historically have had anegative effect on GTSI’s sales and net loss during the quarter ended June 30.

**2.****             ****New Accounting Pronouncements**

InJune 2006, the Financial Accounting Standards Board (“FASB”) issuedInterpretation No. 48, *Accounting for Uncertaintyin Income Taxes* (“FIN 48”), which clarifies the accounting foruncertainty in income taxes recognized in the financial statements inaccordance with FASB Statement No. 109, *Accounting for IncomeTaxes*. FIN 48 provides guidance on the financial statementrecognition, measurement, presentation and disclosure of uncertain taxpositions taken or expected to be taken in income tax returns. FIN 48 iseffective for fiscal years beginning after December 31, 2006. GTSI is currentlyevaluating the impact of this standard on its consolidated financial statements.

InSeptember 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”)No. 157, *Fair Value Measurement*, (“FAS 157”),which establishes a framework for measuring fair value in generally acceptedaccounting principles, and expands disclosures about fair value measurements.FAS 157 is effective for interim periods beginning after November 15, 2007.GTSI is currently evaluating the impact of this standard on its consolidatedfinancial statements.

In September 2006, the SEC released SEC Staff Accounting Bulletin (“SAB”) No. 108,*Considering the Effects of Prior YearMisstatements when Quantifying Misstatements in Current Year FinancialStatements (“SAB 108”)*, which addresses how uncorrected errors inprevious years should be considered when quantifying errors in current yearfinancial statements and requires registrants to consider the effect of allcarry over and reversing effects of prior year misstatements when quantifyingerrors in current year financial statements. SAB 108 allows registrants torecord the effects of adopting the guidance as a cumulative effect adjustmentwhich must be reported as of the beginning of the first fiscal year ending

5

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after November 15, 2006. The Company does not expect SAB 108 tohave a significant effect on the Company’s consolidated financial position orits results of operations.

**3.****             ****Restatement of FinancialStatements**

GTSIrestated its previously issued consolidated financial statements for the yearended December 31, 2005 and the three months ended March 31, 2006.  The restatements are discussed in detail inGTSI’s Annual Report on Form 10-K/A for the year ended December 31, 2005 andQuarterly Report on Form 10-Q/A for the three months ended March 31, 2006,respectively.  The restatements as of andfor the three months ended June 30, 2005 included adjustments for: i) thetransfer of certain receivables to third parties in accordance with FAS 140,ii) overstatement of certain accounts payable and the related cost of sales,and iii) other miscellaneous adjustments.

Asummary of the aggregate effect of these prior period adjustments on GTSI’sconsolidated financial statements is shown below:

ConsolidatedBalance Sheet

December31, 2005

(in thousands)
| ** **                                        | ** ** | **As Previously** | ** ** | ** **           | ** ** |
|---------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                        | ** ** | **Reported**           | ** ** | **As Restated** | ** ** |
| Cash                                              |       | $                      | 22         |                 | $          | 27 |   |
| Accounts  receivable, net                         |       | $                      | 207,886    |                 | $          | 226,356 |   |
| Inventory                                         |       | $                      | 56,666     |                 | $          | 56,819 |   |
| Deferred costs                                    |       | $                      | 14,909     |                 | $          | 17,069 |   |
| Other current  assets                             |       | $                      | 9,118      |                 | $          | 8,605 |   |
| Total current  assets                             |       | $                      | 288,601    |                 | $          | 308,876 |   |
| Long-term  financing receivables and other assets |       | $                      | 4,416      |                 | $          | 23,391 |   |
| Total assets                                      |       | $                      | 306,657    |                 | $          | 345,907 |   |
| Accounts payable                                  |       | $                      | 159,038    |                 | $          | 151,995 |   |
| Financed lease  debt                              |       | $                      | —     |                 | $          | 25,187 |   |
| Accrued  liabilities                              |       | $                      | 16,634     |                 | $          | 16,603 |   |
| Deferred revenue                                  |       | $                      | 3,611      |                 | $          | 6,020 |   |
| Accrued warranty  liabilities                     |       | $                      | 744        |                 | $          | 849 |   |
| Total current  liabilities                        |       | $                      | 228,041    |                 | $          | 248,668 |   |
| Long-term  financed lease debt                    |       | $                      | —     |                 | $          | 15,996 |   |
| Other  liabilities                                |       | $                      | 3,922      |                 | $          | 3,076 |   |
| Total  liabilities                                |       | $                      | 231,963    |                 | $          | 267,740 |   |
| Capital in  excess of par value                   |       | $                      | 42,943     |                 | $          | 45,104 |   |
| Retained  earnings                                |       | $                      | 34,396     |                 | $          | 36,731 |   |
| Treasury stock                                    |       | $                      | (2,694     | )                    | $          | (3,717 | ) |
| Total  stockholders’ equity                  |       | $                      | 74,694     |                 | $          | 78,167 |   |
| Total liabilities and  stockholders’ equity  |       | $                      | 306,657    |                 | $          | 345,907 |   |

 

6

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Consolidated CondensedStatements of Operations (Unaudited)(in thousands, except per share data)
| ** **                              | ** ** | **For the three months ended** | ** ** | **For the six months ended** | ** ** |
|-----------------------------------------|------------|----------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                              | ** ** | **June 30, 2005**                        | ** ** | **June 30, 2005**                      | ** ** |
| ** **                              | ** ** | **As Reported**                               | ** ** | **As Restated**                             | ** ** | **As Reported** | ** ** | **As Restated** | ** ** |
| Sales                                   |       | $                                                  | 176,490    |                                             | $          | 179,122 |   | $ | 337,167 |   | $ | 335,751 |   |
| Cost of sales                           |       | $                                                  | 160,586    |                                             | $          | 160,059 |   | $ | 302,790 |   | $ | 299,295 |   |
| Gross margin                            |       | $                                                  | 15,904     |                                             | $          | 19,063 |   | $ | 34,377 |   | $ | 36,456 |   |
| Selling, general  & admin. expenses |       | $                                                  | 28,398     |                                             | $          | 28,420 |   | $ | 56,689 |   | $ | 56,524 |   |
| Loss from  operations                   |       | $                                                  | (12,494    | )                                                | $          | (9,357 | ) | $ | (22,312 | ) | $ | (20,068 | ) |
| Interest and  other income, net         |       | $                                                  | 354        |                                             | $          | 460 |   | $ | 1,083 |   | $ | 1,153 |   |
| Loss before  income taxes               |       | $                                                  | (12,140    | )                                                | $          | (8,897 | ) | $ | (21,229 | ) | $ | (18,915 | ) |
| Income tax  benefit                     |       | $                                                  | 4,408      |                                             | $          | 3,359 |   | $ | 7,971 |   | $ | 7,133 |   |
| Net loss                                |       | $                                                  | (7,732     | )                                                | $          | (5,538 | ) | $ | (13,258 | ) | $ | (11,782 | ) |
|                                    |       |                                               |       |                                             |       |   |   |   |   |
| Loss per share - basic  and diluted     |       | $                                                  | (0.84      | )                                                | $          | (0.60 | ) | $ | (1.45 | ) | $ | (1.29 | ) |

** **

CondensedConsolidated Statement of Cash Flows

Forthe Six Months Ended June 30, 2005

(inthousands, except per share data)

 
| ** **            | ** ** | **As Previously  Reported** | ** ** | **Adjustment** | ** ** | **As Restated** | ** ** |
|-----------------------|------------|----------------------------------|------------|----------------|------------|----------------------|------------|
| Operating cash  flows |       | 2,565                            |       | (11,420        | )          | (8,855               | )          |
| Investing cash  flows |       | (2,315                           | )          | 111            |       | (2,204               | )          |
| Financing cash flows  |       | (355                             | )          | 11,321         |       | 10,966               |       |

 

**4.  Stock-Based Compensation**

Asof June 30, 2006, the Company has four stock-based employee compensation plans,which are described below.  Prior toJanuary 1, 2006, the Company accounted for those plans under the recognitionand measurement provisions of APB Opinion No. 25, *Accountingfor Stock Issued to Employees,*(“APB 25”) and relatedInterpretations, as permitted by FASB Statement No. 123, *Accountingfor Stock-Based Compensation* (“FAS 123”).  No stock-based employee compensation cost wasrecognized in the condensed consolidated Statement of Operations for the threeor six months ended June 30, 2005, as all options granted under those plans hadan exercise price equal to the market value of the underlying common stock onthe date of grant.  Effective January 1,2006, the Company adopted the fair value recognition provisions of FASBStatement No. 123(R), *Share-Based Payment*,(“FAS 123R”), using the modified-prospective-transition method.  Under that transition method, compensationcost recognized in the three and six months ended June 30, 2006 includes: (a)compensation cost for all share-based payments granted prior to, but not yetvested as of January 1, 2006, based on the grant date fair value estimated inaccordance with the original provisions of FAS 123, and (b) compensation costfor all share-based payments granted subsequent to January 1, 2006, based onthe grant-date fair value estimated in accordance with the provisions of FAS123R.  Results for the prior periods havenot been restated.

Asa result of adopting FAS 123R on January 1, 2006, the Company’s reported lossfrom operations, loss before income taxes and net loss for the three and sixmonths ended June 30, 2006 are $304 thousand and $493 thousand lower,respectively, than if it had continued to account for share-based compensationunder APB 25.

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Priorto the adoption of FAS 123R, the Company presented all tax benefits of deductionsresulting from the exercise of stock options as operating cash flows in thecondensed consolidated Statement of Cash Flows. FAS 123R requires the cash flows resulting from the tax benefitsresulting from tax deductions in excess of the compensation cost recognized forthose options (excess tax benefits) to be classified as financing cashflows.  Since there was no tax benefitfor stock options during the three or six months ended June 30, 2006, there wasno impact on the Company’s Statement of Cash Flows for the adoption of FAS123R.

Thefollowing table illustrates the effect on net loss and loss per share if theCompany had applied the fair value recognition provisions of FAS 123 to optionsgranted under the Company’s stock option plans for the three and six monthsended June 30, 2005.  For purposes ofthis pro forma disclosure, the value of the options is estimated using aBlack-Scholes-Merton option-pricing formula and amortized to expense over theoptions’ vesting periods, as a single award.
| ** **                                                                                                                                        | ** ** | **Three months ended**     | ** ** | **Six months ended**       | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                                                                        | ** ** | **June 30, 2005**          | ** ** | **June 30, 2005**          | ** ** |
| **(in thousands, except per share data)**                                                                                | ** ** | **(restated  see Note 3)** | ** ** | **(restated  see Note 3)** | ** ** |
| Net loss — as  reported                                                                                                                      |       | $                                    | (5,538     | )                                    | $          | (11,782 | ) |
| Deduct: Total  stock-based employee compensation expense determined under the fair value  based method for all awards, net of related tax effects |       | (165                                 | )          | (848                                 | )          |
| Net loss — pro  forma                                                                                                                        |       | $                                    | (5,703     | )                                    | $          | (12,630 | ) |
|                                                                                                                                              |       |                                 |       |                                 |       |
| Loss per share,  basic and diluted — as reported                                                                                             |       | $                                    | (0.60      | )                                    | $          | (1.29 | ) |
|                                                                                                                                              |       |                                 |       |                                 |       |
| Loss per share, basic  and diluted — pro forma                                                                                               |       | $                                    | (0.62      | )                                    | $          | (1.38 | ) |

 

*StockIncentive Plans*

TheCompany has two stockholder approved combination incentive and non-statutorystock incentive plans: the 1994 Stock Option Plan, as amended (“1994 Plan”),and the Amended and Restated 1996 Stock Incentive Plan (“1996 Plan”). Theseplans provide for the granting of options to employees (both plans) andnon-employee directors (only under the 1996 Plan) to purchase up to 300,000 and3,500,000 shares, respectively, of the Company’s common stock. The 1996 Planalso permits the grant of restricted stock units to its employees andnon-employee directors. The Company has another stockholder approved plan, the1997 Non-Officer Stock Option Plan (“1997 Plan”), which provides for thegranting of non-statutory stock options to employees (other than officers anddirectors) to purchase up to 300,000 shares of the Company’s common stock. Inaddition, GTSI has utilized a vehicle permitted under NASDAQ marketplace rulesthat allows a company without stockholder approval to offer stock options toprospective employees as an inducement to join GTSI (“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 at the date of grant.The vesting period for restricted stock and restricted stock units is determinedby the Compensation Committee on an individual award basis. GTSI recognizesstock-based compensation expense for these graded vesting awards on astraight-line basis over the requisite service period for the entire award,which is equal to the vesting period specified in the option agreement.

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*ValuationAssumptions*

Thefair value of each option award is estimated on the date of grant using aBlack-Scholes-Merton option valuation model that uses the assumptions noted inthe following table.  Expected volatilitiesare based on the historical volatility of GTSI’s stock.  The Company uses historical data to estimateoption exercises and employee terminations within the valuation model.  The expected term of options granted has beendetermined based on historical exercise behavior and represents the period oftime that options granted are expected to be outstanding.  The risk-free interest rate is based on thefive year U.S. Treasury rates at the time of grant which approximates GTSI’s4.8 year expected term of the option.

|                           | ** ** | **Three months ended** | ** ** |
|---------------------------|------------|----------------------------------|------------|
| ** **                | ** ** | **June 30, 2006**      | ** ** |
| Expected  volatility      |       | 49.9                             | %          |
| Expected  dividends       |       | —                           |       |
| Expected term  (in years) |       | 4.8                              |       |
| Risk-free rate            |       | 5.0                              | %          |

* *

*Stock Options*

Asummary of option activity under the Company’s stock incentive plans as of June30, 2006 and changes during the period then ended is presented below:
| **Options**                     | ** ** | **Shares  (000)** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Weighted-  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value  ($000)** | ** ** |
|---------------------------------|------------|-------------------|------------|-----------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------|------------|
|                            |       |              |       |                                    |       |                                                 |       |                                    |       |
| Outstanding at  January 1, 2006 |       | 2,088             |       | $                                       | 8.57       |                                                 |       |                                    |       |   |
| Granted                         |       | 733               |       | $                                       | 6.73       |                                                 |       |                                    |       |   |
| Exercised                       |       | (138              | )          | $                                       | 4.44       |                                                 |       |                                    |       |   |
| Forfeited                       |       | (92               | )          | $                                       | 7.87       |                                                 |       |                                    |       |   |
| Expired                         |       | (255              | )          | $                                       | 10.85      |                                                 |       |                                    |       |   |
| Outstanding at  June 30, 2006   |       | 2,336             |       | $                                       | 8.01       |                                                 | 5.0        |                                    | $          | 740 |   |
| Exercisable at June 30,  2006   |       | 1,489             |       | $                                       | 8.56       |                                                 | 4.1        |                                    | $          | 734 |   |

 

Theweighted-average grant-date fair value of options granted during the threemonths ended June 30, 2006 and 2005 was $6.74 and $8.41, respectively.  The total intrinsic value of optionsexercised during the three months ended June 30, 2006 and 2005 was $19 thousandand $1,758 thousand, respectively. Duringthe three months ended June 30, 2006, 15 thousand stock options were exercisedunder the Company’s stock option plans and issued from treasury stock. Duringthe six months ended June 30, 2006, a Company executive exercised 100,000options and received 31,073 shares of GTSI common stock that were issued fromthe Company’s treasury stock. In addition, 37,500 other options were exercisedduring the six months ended June 30, 2006 and issued from treasury stock. Dueto the full valuation allowance on the Company’s deferred tax assets, no taxbenefit for the exercise of stock options was recognized during the six monthsended June 30, 2006. The tax benefit of stock options exercised during thethree and six months ended June 30, 2005 was $681 thousand and $775 thousand,respectively.

Forthe three months ended June 30, 2006 and 2005, the Company recorded charges of$33 thousand for each period, for stock-based compensation granted to non-employeesbased on the fair value method.

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*RestrictedShares*

Duringthe six months ended June 30, 2006, 1,667 shares of restricted stock weregranted. During the six months ended June 30, 2005, the Company issuedrestricted stock grants of 26,664 shares of the Company’s common stock to thenon-employee members of the Board, which vested in June 2006. The Companyrecorded approximately $12 thousand and $218 thousand, respectively, instockholders’ equity for deferred compensation for the six months ended June30, 2006 and 2005.  The deferredcompensation is amortized on a straight-line basis over the vesting period ofthe grants. During the six months ended June 30, 2006 and 2005, approximately$102 thousand and $18 thousand, respectively, was recorded as stockcompensation expense for restricted stock.

Thefair value of nonvested shares of restricted stock is determined based on theclosing trading price of the Company’s shares on the grant date. A summary ofthe status of Company’s nonvested shares as of June 30, 2006, and changesduring the period ended June 30, 2006, is presented below:

| Nonvested Shares         | ** ** | **Shares  (000)** | ** ** | **Weighted-Average  Grant-Date Fair Value** | ** ** |
|-------------------------------|------------|-------------------|------------|-------------------------------------------------------|------------|
| Nonvested at  January 1, 2006 |       | 50                |       | $                                                     | 8.16       |   |
| Granted                       |       | 2                 |       | $                                                     | 7.20       |   |
| Cancelled                     |       | (3                | )          | $                                                     | 8.09       |   |
| Restricted lapse              |       | (27               | )          | $                                                     | 8.19       |   |
| Nonvested at June 30,  2006   |       | 22                |       | $                                                     | 8.02       |   |

 

*UnrecognizedCompensation*

Asof June 30, 2006, there was $3.1 million of total unrecognized compensationcost related to nonvested stock-based awards. That cost is expected to be recognized over a period of 5.1 years.  During the three and six months ended June30, 2006, respectively, 10,000 and 16,000 awards vested.

**5.   Lease Receivables**

TheCompany offers lease arrangements to its customers. These arrangements typicallyare for periods from two to four years and are accounted for as sales-typeleases. The Company’s net investment in leases as included in the consolidated balance sheets in accounts receivable,net were as follows (in thousands):

|                                           | ** ** | **June 30, 2006** | ** ** | **December 31, 2005** | ** ** |
|-------------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| ** **                                | ** ** | ** **                  | ** ** | **(restated  see Note 3)**      | ** ** |
| Future minimum  lease payments receivable |       | $                           | 53,082     |                            | $          | 30,736 |   |
| Unguaranteed  residual values             |       | 10,808                      |       | 8,723                           |       |
| Unearned income                           |       | (9,103                      | )          | (6,328                          | )          |
| Net investment in lease                   |       | $                           | 54,787     |                            | $          | 33,131 |   |

 

**6.   Inventory**

Inventoryis valued at the lower of cost or market. The Company writes down its inventoryfor obsolete or excess inventory based on assumptions about future demand andmarket conditions by recording a reserve to inventory on the balance sheet. Asof June 30, 2006 and December 31, 2005, the balance of the reserve was $3.6million and $6.8 million, respectively.

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**7.   Debt**

a. Credit Agreements

The Company entered into a credit agreementof $125 million on June 2, 2006 with SunTrust Bank and Bank of America, N.A. toprovide a credit facility in an aggregate amount not to exceed $125 million(the “Credit Agreement”). This Credit Agreement replaced GTSI’s former creditfacility which expired on May 31, 2006.

The Credit Agreement provides access tocapital through June 2, 2010 with borrowings secured by substantially all ofthe assets of the Company. Borrowing under the Credit Agreement at any time islimited to the lesser of $125 million or a collateral-based borrowing base lessoutstanding obligations. The Credit Agreement subjects GTSI to certaincovenants limiting its ability to (i) freely incur debt; (ii) make certainguarantees; (iii) make certain restricted payments, purchases or investments;(iv) enter into specified transactions with affiliates; (v) acquire real estateand (vii) enter into sales and leaseback transactions. The Credit Agreementcarries an interest rate generally indexed to the Prime Rate plus 25 basispoints. The average interest rate for the three months ended June 30, 2006 was8.0%.  The Credit Agreement containsnegative financial performance covenants, information covenants and certainaffirmative covenants. As of June 30, 2006, GTSI was in compliance with allcovenants set forth in the Credit Agreement. As of June 30, 2006 GTSI hadavailable credit under the Credit Agreement of $31.1 million.

On June 2, 2006, the Company also enteredinto a subordinated secured long-term loan agreement with Crystal Capital Fund,L.P. (the “Term Loan”) to provide an additional $10 million of financing.  The interest rate on the Term Loan is Primeplus 5.0% per annum. The average interest rate for the three months ended June30, 2006 was 13.0%.  This agreementcontains a prepayment penalty if the Company chooses to repay the loan beforeone year.

On July 13, 2006, GTSI executed a FirstAmendment to the Credit Agreement to increase the revolving credit agreement$10 million to $135 million and add several banks to the lender syndicate.

On November 30, 2006, GTSI and its lendersexecuted a Second Amendment to the Company’s Credit Agreement to revise severalprovisions contained in Definitions, Interest, Minimum EBITDA, and Fixed ChargeCoverage Ratio sections.  In exchange forthese financial accommodations the Company agreed to make a one-time payment toeach Lender in an amount equal to 0.15% of such Lender’s portion of theRevolving Loan Commitment. Non-compliance with the covenants would allow thecreditors to accelerate the loan under certain conditions.

On November 30, 2006, GTSI and its whollyowned subsidiaries also amended the Company’s Term Loan by entering into anamendment with the Lenders and Crystal Capital Fund, L.P., under similar termsas the Second Amendment to the Credit Agreement.

b. Financed Lease Debt

As the transfers of the financing receivablesdid not meet the sale criteria under FAS 140, the receipts of cash from thethird party financing companies are accounted for as secured borrowings, whichare included in the accompanying consolidated balance sheets as financed leasedebt.   The Company has received cash of$5.9 million and $2.4 million for the three months ended June 30, 2006 and2005, respectively, and received cash of $14.0 million and $11.3 million forthe six months ended June 30, 2006 and 2005, respectively, related to thetransfer of certain financing receivables to third parties.

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The terms of the financed lease debtgenerally correspond to the terms of the underlying lease agreements, generallytwo to four years.  The secured financeddebt is secured by the related lease and other receivables.   The Company recognized interest expenseassociated by the secured financing debt of $0.8 million and $0.3 million forthe three months ended June 30, 2006 and 2005, respectively, and of $1.5million and $0.5 million for the six months ended June 30, 2006 and 2005,respectively.

**8.  Contract Termination Costs**

InOctober 2005 and February 2006 the Company implemented two reductions inworkforce to eliminate duplication within the organization and move out ofactivities which have failed to yield adequate profitability. These actionsresulted in excess office space for which the Company recorded a charge duringthe quarter ended June 30, 2006 of $166 thousand for the consolidation offacilities. Of the remaining $151 thousand liability at June 30, 2006, $89thousand represents a non-current liability for costs to be incurred though2008 related to facilities that are sub-leased or anticipated to be sub-leasedat rates below the Company’s costs. This charge is included in selling, general& administrative expenses on the accompanying Statement of Operations.During the three months ended June 30, 2006 GTSI received $120 thousand of subleaseincome for this excess space. Although the sublease ended during the secondquarter, the Company continues to actively market the space available in aneffort to offset future expenses.

Changes in the contract termination cost reserve for the quarter endedJune 30, 2006 (in thousands) were as follows:

| Contract termination charge                         |   | $   | 166 |   |
|-----------------------------------------------------|--------|-----|-----|--------|
| Less: Cash  payments                                |   | (15 | )   |
| Contract termination  liability as of June 30, 2006 |   | $   | 151 |   |

 

**9.  Earnings (Loss) Per Share**

Basicloss per share is calculated by dividing net loss by the weighted averageshares outstanding during the period, which includes shares of restricted stockthat are fully vested.  Diluted loss pershare is computed similarly to basic loss per share, except that the weightedaverage shares outstanding are increased to include equivalents, when theireffect is dilutive.

Antidilutiveemployee stock options totaling 634 thousand shares have been excluded for thethree months ended June 30, 2005. Anti-dilutive employee stock options totaling227 thousand and 642 thousand shares were excluded for the six months endedJune 30, 2006 and 2005, respectively. Unvested restricted stock units totaling23 thousand and 6 thousand shares have been excluded for the three months endedJune 30, 2006 and 2005, respectively. Unvested restricted stock units totaling24 thousand and 3 thousand shares have been excluded for the six months endedJune 30, 2006 and 2005, respectively.

The following table setsforth the computation of basic and diluted earnings per share (in thousands,except per share amounts):

 
| ** **                           | ** ** | **Three months ended** | **  ** | **Six months ended **             | ** ** |
|--------------------------------------|------------|----------------------------------|------------------|--------------------------------------------------|------------|
| ** **                           | ** ** | **June 30,**                | ** **       | **June 30,**                                | ** ** |
| ** **                           | ** ** | **2006**                         | ** **       | **2005**                                         | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                           | ** ** | ** **                       | ** **       | **(restated –  see Note 3)** | ** ** | ** ** | ** ** | **(restated –  see Note 3)** | ** ** |
| Numerator:                           |       |                             |             |                                             |       |   |   |   |   |
| Net income (loss)                    |       | $                                | 944              |                                             | $          | (5,538 | ) | $ | (9,083 | ) | $ | (11,782 | ) |
|                                 |       |                             |             |                                             |       |   |   |   |   |
| Denominator:                         |       |                             |             |                                             |       |   |   |   |   |
| Weighted average  shares outstanding |       |                             |             |                                             |       |   |   |   |   |
| Basic                                |       | 9,348                            |             | 9,243                                            |       | 9,331 |   | 9,123 |   |
| Effect of dilutive securities        |       | 117                              |             | N/A                                              |       | N/A |   | N/A |   |
| Diluted                              |       | 9,465                            |             | 9,243                                            |       | 9,331 |   | 9,123 |   |
|                                 |       |                             |             |                                             |       |   |   |   |   |
| Net earnings (loss)  per share:      |       |                             |             |                                             |       |   |   |   |   |
| Basic                                |       | $                                | 0.10             |                                             | $          | (0.60 | ) | $ | (0.97 | ) | $ | (1.29 | ) |
| Diluted                              |       | $                                | 0.10             |                                             | $          | (0.60 | ) | $ | (0.97 | ) | $ | (1.29 | ) |

 

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**10.   Income Taxes**

TheCompany has provided a valuation allowance against the full amount of the netdeferred tax assets at June 30, 2006 because, in the opinion of management, itis not more likely than not that these deferred tax assets will be realized.Therefore, no income tax benefit was reported in the Statement of Operations onthe loss before income taxes of $9.1 million for the six months ended June 30,2006.

** 11.    Commitments and Contingencies**

*ProductWarranties*

GTSIoffers extended warranties on certain products which are generally covered forthree or five years beyond the warranty provided by the manufacturer.  Products under extended warranty requirerepair or replacement of defective parts at no cost to the customer.  The Company records warranty liabilities atthe time of sale for the estimated costs that may be incurred under itsextended warranty contracts.  Thefollowing table summarizes the activity related to product warranty liabilities(in thousands):
| ** **                                 | ** ** | **Six months ended** | ** ** |
|--------------------------------------------|------------|--------------------------------|------------|
| ** **                                 | ** ** | **June 30,**              | ** ** |
| ** **                                 | ** ** | **2006**                       | ** ** | **2005** | ** ** |
| Accrued  warranties at beginning of period |       | $                              | 849        |   | $ | 2,429 |   |
| Charges made  against warranty liabilities |       | (217                           | )          | (767 | ) |
| Adjustments to  warranty reserves          |       | 173                            |       | (196 | ) |
| Accruals for  additional warranties sold   |       | 38                             |       | 159 |   |
| Accrued warranties at  end of period       |       | $                              | 843        |   | $ | 1,625 |   |

 

Revenueand cost of sales from extended warranty contracts is recorded as deferredrevenue and deferred costs, respectively, and subsequently recognized over theterm of the contract.  The followingtable summarizes the activity related to the deferred warranty revenue (in thousands):
| ** **                                        | ** ** | **Six months ended** | ** ** |
|---------------------------------------------------|------------|--------------------------------|------------|
| ** **                                        | ** ** | **June 30,**              | ** ** |
| ** **                                        | ** ** | **2006**                       | ** ** | **2005** | ** ** |
| Deferred  warranty revenue at beginning of period |       | $                              | 1,361      |   | $ | 2,599 |   |
| Deferred  warranty revenue recognized             |       | (557                           | )          | (729 | ) |
| Revenue deferred  for additional warranties sold  |       | 227                            |       | 72 |   |
| Deferred warranty  revenue at end of period       |       | $                              | 1,031      |   | $ | 1,942 |   |

 

*Letters of Credit*

GTSIwas obligated under an operating lease to provide its landlord with a letter ofcredit in the amount of $150 thousand at June 30, 2006 and December 31, 2005,as a security deposit for all tenant improvements associated with the lease.

Asof June 30, 2006, the Company had an outstanding letter of credit, scheduled toexpire in June 2007, to a customer in the amount of $4.6 million to guaranteethe performance by the Company of its obligations under the contract. GTSIprovided one of its vendors a $3.0 million letter of credit as collateral for aline of credit of $25 million.

Asof December 31, 2005, GTSI had an outstanding letter of credit to a customer inthe amount of $1.75 million to guarantee the performance by the Company of allobligations under the contract.  Thisobligation expired on February 28, 2006.

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*EmploymentAgreements*

Asof December 31, 2005, the Company had an employment agreement with its formerChief Executive Officer which provided for payment of $0.7 million upontermination of employment. This agreement was terminated on February 15, 2006when the Company entered into a transition agreement with its former CEO (the “TransitionAgreement”). The Transition Agreement provides for a payment of $1.1 million tobe paid out over the next 18 months, as well as reimbursement for certainbenefits and legal fees totaling $0.1 million. As a result, the Companyrecorded severance expense of $1.2 million in selling, general & administrativeexpenses during the six months ended June 30, 2006. As of June 30, 2006, theremaining severance liability was $1.2 million which is reported in accruedliabilities.

OnFebruary 16, 2006, GTSI entered into an employment agreement with the Company’scurrent President and Chief Executive Officer. This agreement provides forpayments of 12 months of base salary plus bonus equal to the previous year’sbonus payments upon termination of employment or a change in control. Inaddition, GTSI has change in control agreements with 15 additional executivesand key employees. These arrangements provide for payments of as much as 18months of total target compensation and continuation of benefits upon theoccurrence of specified events. As of June 30, 2006 no accruals have beenrecorded for these agreements.

*Contingencies*

Currently,and from time to time, GTSI is involved in litigation incidental to the conductof its business.  As of June 30, 2006,GTSI is not a party to any lawsuit or proceeding that, in the opinion ofmanagement, is likely to have a material adverse effect on its financialposition or results of operations.

**12.   Subsequent Events**

OnAugust 14, 2006, GTSI received a staff determination letter from NASDAQNational Market stating that, because the Company has not filed this form 10-Qwith the SEC, its stock is subject to delisting from the NASDAQ NationalMarket. On September 14, 2006, Company representatives met with the NASDAQHearing Panel and GTSI was granted an extension in order to remedy its filingdelinquency. The Panel determined to continue listing of GTSI’s shares on theNASDAQ stock market until October 31, 2006, by which time the Company wasexpected to file its Form 10-Q for the three months ended June 30, 2006.  On December4, 2006, GTSI received a staffdetermination letter from NASDAQ National Market granting GTSI an extension to January 9, 2007 to satisfy the requirements forcontinued listing under Nasdaq Market Place Rule 4310(c)(14), subject to theCompany filing its Form 10-Q for the quarter ended June 30, 2006, its Form 10-Qfor the quarter ended September 30, 2006, and all required restatements ofprior period financial statements.

OnAugust 16, 2006, GTSI announced that its newly hired VP of Finance andCorporate Controller, Joe Ragan, was promoted to the position of Senior VicePresident and Chief Financial Officer. Mr. Ragan succeeded Thomas A. Mutrynupon his resignation after three and one half years with the Company.

OnDecember 22, 2006, GTSI filed an amended Form 10-K/A with the SEC to restateits prior financial statements for the quarterly and annual periods endedDecember 31, 2005, 2004 and 2003. The restated amounts are included in thecomparative information contained in this Form 10-Q as detailed in Note 3 ofthe consolidated condensed financial statements.

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**ITEM 2.****        ****MANAGEMENT’SDISCUSSION AND ANALYSIS 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 unaudited condensed consolidated financialstatements and notes included in Part I, Item 1 of this Quarterly Report onForm 10-Q and our consolidated financial statements and notes in our AnnualReport on Form 10-K/A for the year ended December 31, 2005.  We use the terms “GTSI,” “we,” “our,” and “us”to refer to GTSI Corp. and its subsidiaries.

**Disclosure Regarding Forward-Looking Statements**

Readersare cautioned that this Quarterly Report on Form 10-Q 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,relating to our operations that are based on our current expectations,estimates, forecasts and projections. Words such as “expect,” “plan,” “believe,” “anticipate,”  “intend” and similar expressions are intendedto identify these forward-looking statements. These statements are not guarantees of future performance and aresubject to risks, uncertainties and assumptions that are difficult topredict.  Therefore, actual results infuture periods may differ materially from those expressed or projected in anyforward-looking statements because of a number of risks and uncertainties,including:

·                  Materialweaknesses in our internal control over financial reporting;

·                  Theuncertainty surrounding our ability to meet the covenants under our CreditAgreement in future periods;

·                  Infrastructurefailures;

·                  Ourexposure to inventory risks;

·                  Changesin our management team, including our Chief Executive Officer who resigned February15, 2006;

·                  Continuingnet losses, if we fail to align costs with our sales levels;

·                  Ourreliance on a small number of large transactions for significant portions ofour sales and gross margins;

·                  Ourability to shift our business model from a reseller of products to a high-endsolutions provider;

·                  Potentialadditional expenses to comply with the changing regulations of corporategovernance and public disclosure;

·                  Ourability to attract and retain talented employees;

·                  Ourquarterly sales and cash flows are volatile, which makes our future financialresults difficult to forecast;

·                  Unsatisfactoryperformance by third parties with which we work could hurt our reputation,operating results and competitiveness;

·                  Anyissue that compromises our relationship with agencies of the Federal governmentwould cause serious harm to our business;

·                  Competitionand loss of market share;

·                  Ourqualifications as a small business for new contract awards; and

·                  Changesin Federal government fiscal spending.

For a detailed discussion of risk factors affecting GTSI’s business andoperations, see Item 1A, Risk Factors in our Annual Report on Form 10-K/A forthe year ended December 31, 2005. We undertake no obligation to revise orupdate any forward-looking statements.

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**Restatement**

InAugust 2006, management concluded that GTSI’s financial statements for the yearended December 31, 2005 and the quarter ended March 31, 2006 should be restatedto correct the accounting for the transfer of receivables, the overstatement ofaccounts payable and the related costs of sales, and the recording ofmiscellaneous accounting adjustments appropriate for the fair presentation ofthe financial statements. As result of the corrections of these errors, werestated our financial statements as described more fully in Note 3 of ourunaudited condensed consolidated financial statements in this Form 10-Q.Following the restatement, income on certain transferred receivables is beingrecognized over the term of the respective lease agreements, along withinterest expense on financed lease debt. In addition, the transferredreceivables together with related liabilities are reported in GTSI’s balancesheets following the restatement. These restatement entries resulted in anincrease of $39.3 million in total assets and $35.8 million in totalliabilities as of December 31, 2005 and a decrease to net loss of $1.5 million,or $0.16 per share, for the six months ended June 30, 2005. Additionally, therestatement entries affected the Statement of Cash Flows by moving cash flowsfrom operations to cash flows from financing activities, resulting in adecrease to cash provided by operating activities of $11.4 million andincreases to cash provided by investing and financing activities of $0.1million and $11.3 million, respectively for the six months ended June 30, 2006.This Management’s Discussion and Analysis of Financial Condition and Results ofOperations has been modified and updated to reflect the effect of theserestatements.

**Overview**

GTSIhas more than 20 years of experience in selling IT products and solutionsprimarily to U.S. Federal Government customers. We believe our key differentiators to be our strong brand amonggovernment customers, extensive contract portfolio and wide variety of vendors.

Thevast majority of the IT solutions we offer to our customers have a strongproduct component, and many are entirely product-based.  We connect IT’s leading vendors, products andservices inside the core technology areas most critical to government successby partnering with global IT leaders such as Panasonic, HP, Cisco and SunMicrosystems.  In our traditionalreseller capacity, we provide governments with products for workgroupcomputing, 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.

During2005, we focused 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 oninvestment.  Our primary solutionattention is being directed toward IT consolidation, disaster recovery andbackup, e-mail management, and visual communication support for remote workersand distributed offices, including collaboration, presentation, and broadcastsystems.

Tohelp our customers acquire, manage and refresh this technology in a strategicand application-appropriate manner, GTSI has created a mix of financialservices capable of managing the entire technology lifecycle.  We offer leasing arrangements to allowgovernment agencies to acquire access to technology as an evenly distributedoperating expense, rather than the much more budget-sensitive and discontinuouscapital expenditures.  This model is inhigh demand from our customers, and we believe it represents a distinctiveadvantage.  We expect to continue toexpand our sales from leasing arrangements for IT products and solutions in2006.

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Asdiscussed in more detail throughout our MD&A for the six months ended June30, 2006 compared to June 30, 2005:

·                  Totalsales declined $6.5 million;

·                  Grossmargin as a percentage of sales increased 2.8 percentage points;

·                  Operatingexpenses were impacted by approximately $3.1 million of non-recurring chargesrelated to re-financing our debt, severance and restatement fees; and

·                  Lossbefore income taxes decreased $9.8 million predominantly due to the $8.4million increase in gross margin, despite our decrease in sales.

Weare looking forward to significant improvements in operational and financialperformance through improved margin percentages.  We have put in place a multi-element plan tomove the business from lower margin product sales to higher margin solutionssales.  In the first element of our plan,we identified and exited failing or non-strategic activities, including tworeductions in workforce totaling over 100 full time positions and realigningfunctions throughout GTSI to increase margin improvement through costreductions.  In the second and thirdelements of our plan, which will progress throughout 2006 and into 2007, wewill work to improve execution of the current business and deliver high valuesolutions.  We believe there aresignificant opportunities to increase our relatively low market share withinthe government IT market as we pursue a distinctive business model combiningthe concepts of a value added provider of complex IT solutions with atraditional reseller.

**Critical Accounting Estimates and Policies**

Ourunaudited condensed consolidated financial statements are based on theselection of accounting policies and the application of significant accountingestimates, some of which require management to make significantassumptions.  We believe that some of themore critical estimates and related assumptions that affect our financialcondition and results of operations pertain to revenue recognition, financingreceivables, valuation of inventory, capitalized internal use software,accounts payable and income taxes. For more information on critical accountingestimates and policies see the MD&A included in our Annual Report on Form10-K/A for the year ended December 31, 2005. We have discussed the application of these critical accounting estimatesand policies with the Audit Committee of our Board of Directors.

Weadopted SFAS No. 123 (Revised 2004), *Share-Based Payment*(“FAS 123R”) as of January 1, 2006 and as a result, we changed theaccounting for our stock option plans from the intrinsic value method, usedprior to 2006, to the fair value method as required by FAS 123R. We adopted FAS123R using the modified-prospective-transition method. As a result of the adoption,our stock-based compensation expense increased $0.2 million during the threemonths ended June 30, 2006, which was recorded as selling, general &administrative expenses on our condensed consolidated Statement of Operations.In accordance with the modified-prospective-transition method, our consolidatedfinancial statements for prior periods have not been restated to reflect, anddo not include, the impact of FAS 123R. There was no stock-based compensationexpense related to employee stock options recognized during the three monthsended June 30, 2005 because the exercise price of the stock options granted toemployees and directors equaled the fair market value of the underlying stockon the date of grant.

Weexpect that the adoption of FAS 123R will result in additional expenses, ascompared to 2005, of approximately $1.1 million based on stock optionsoutstanding as of June 30, 2006.  We areunable to predict the ultimate impact to our annual operations, as it willdepend on the level of share-based awards in 2006 and thereafter, and theactual rate of forfeitures, as compared to our estimate of forfeitures.

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FAS123R requires companies to estimate the fair value of share-based paymentawards on the date of grant using an option-pricing model. The value of theportion of the award that is ultimately expected to vest is recognized asexpense over the requisite service periods in our condensed consolidatedStatement of Operations. Our determination of fair value of share-based paymentawards on the date of grant using an option-pricing model is affected byassumptions regarding a number of highly complex and subjective variables.These variables include our expected stock price volatility, expected term,risk free interest rates, and actual and projected employee stock optionexercise behaviors.

Weanalyzed our historical volatility to estimate the expected volatility,consistent with FAS 123R. The risk-free interest rate assumption is thefive-year U.S. Treasury rates at the date of grant. The estimated expected liferepresents the weighted-average period the stock options are expected to remainoutstanding and has been determined based on an analysis of historical exercisebehavior.

Asstock-based compensation expense recognized in the condensed consolidatedStatement of Operations for the first half of 2006 is based on awardsultimately expected to vest, it has been reduced for estimated forfeitures.Forfeitures were estimated based on historical experience. As of June 30, 2006,the total compensation cost related to nonvested awards not yet recognized was$3.1 million, which will be recognized over a period of 5.1 years.

Duringthe year ended December 31, 2005, the Company’s Board of Directors approved theacceleration of the vesting of unvested stock options with an exercise pricehigher than $8.09, the market value on the date of the acceleration, previouslyawarded to employees, officers and directors under GTSI’s stock optionplans.  This action affected unvestedoptions to purchase an aggregate of 515 thousand shares of common stock atexercise prices per share between $8.23 and $13.67.  The vesting of these options was acceleratedto avoid recognizing compensation expense in future financial statements uponthe adoption of FAS 123R.

**HistoricalResults of Operations**

Thefollowing table illustrates the unaudited percentage of sales represented byitems in our condensed consolidated statements of operations for the periodspresented.
| ** **                                      | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|-------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                      | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                      | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                      | ** ** | ** **                       | ** ** | **(restated)**                 | ** ** | ** ** | ** ** | **(restated)** | ** ** |
| Sales                                           |       | 100.0                            | %          | 100.0                          | %          | 100.0 | % | 100.0 | % |
| Cost of sales                                   |       | 85.4                             |       | 89.4                           |       | 86.4 |   | 89.1 |   |
| Gross margin                                    |       | 14.6                             |       | 10.6                           |       | 13.6 |   | 10.9 |   |
| Selling, general  & administrative expenses |       | 15.0                             |       | 15.9                           |       | 17.2 |   | 16.8 |   |
| Loss from  operations                           |       | (0.4                             | )          | (5.3                           | )          | (3.6 | ) | (5.9 | ) |
| Interest and  other income, net                 |       | 0.9                              |       | 0.3                            |       | 0.8 |   | 0.3 |   |
| Income (loss)  before income taxes              |       | 0.5                              |       | (5.0                           | )          | (2.8 | ) | (5.6 | ) |
| Income tax  benefit                             |       | —                           |       | 1.9                            |       | — |   | 2.1 |   |
| Net income (loss)                               |       | 0.5                              | %          | (3.1                           | )%         | (2.8 | )% | (3.5 | )% |

 

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The following tables indicate, for the periods indicated (dollars inmillions), the approximate sales by type and vendor along with relatedpercentages of total sales.
| ** **                           | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30** | ** ** |
|--------------------------------------|------------|-----------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                           | ** ** | **2006**                                            | ** ** | **2005**                                         | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                           | ** ** | ** **                                          | ** ** | ** **                                       | ** ** | **(restated)** | ** ** | ** ** | ** ** | ** ** | ** ** | **(restated)** | ** ** |
| **Sales by Type**          |       |                                                |       |                                             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Hardware, net of  reserves           |       | $                                                   | 131.3      |                                             | 72.5       | % | $ | 136.4 |   | 76.1 | % | $ | 246.0 |   | 74.7 | % | $ | 264.2 |   | 78.6 | % |
| Software                             |       | 34.1                                                |       | 18.8                                             |       | 28.3 |   | 15.8 |   | 47.1 |   | 14.3 |   | 44.5 |   | 13.3 |   |
| Resold  third-party service products |       | 6.8                                                 |       | 3.8                                              |       | 9.1 |   | 5.1 |   | 15.2 |   | 4.6 |   | 19.1 |   | 5.7 |   |
| Services                             |       | 8.8                                                 |       | 4.9                                              |       | 5.3 |   | 3.0 |   | 20.9 |   | 6.4 |   | 8.0 |   | 2.4 |   |
| Total                                |       | $                                                   | 181.0      |                                             | 100.0      | % | $ | 179.1 |   | 100.0 | % | $ | 329.2 |   | 100.0 | % | $ | 335.8 |   | 100.0 | % |

 
| ** **                    | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30** | ** ** |
|-------------------------------|------------|-----------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                    | ** ** | **2006**                                            | ** ** | **2005**                                         | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                    | ** ** | ** **                                          | ** ** | ** **                                       | ** ** | **(restated)** | ** ** | ** ** | ** ** | ** ** | ** ** | **(restated)** | ** ** |
| **Sales by Vendor** |       |                                                |       |                                             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Panasonic                     |       | $                                                   | 30.7       |                                             | 16.9       | % | $ | 33.0 |   | 18.4 | % | $ | 64.2 |   | 19.5 | % | $ | 72.6 |   | 21.6 | % |
| Cisco                         |       | 22.4                                                |       | 12.4                                             |       | 15.2 |   | 8.5 |   | 47.1 |   | 14.3 |   | 32.2 |   | 9.6 |   |
| HP                            |       | 18.1                                                |       | 10.0                                             |       | 19.5 |   | 10.9 |   | 34.3 |   | 10.4 |   | 38.7 |   | 11.5 |   |
| Sun Microsystems              |       | 18.7                                                |       | 10.4                                             |       | 15.3 |   | 8.5 |   | 28.9 |   | 8.8 |   | 30.0 |   | 8.9 |   |
| Microsoft                     |       | 20.9                                                |       | 11.5                                             |       | 17.0 |   | 9.5 |   | 23.8 |   | 7.2 |   | 19.3 |   | 5.8 |   |
| Others, net of  reserves      |       | 70.2                                                |       | 38.8                                             |       | 79.1 |   | 44.2 |   | 131.1 |   | 39.8 |   | 143.0 |   | 42.6 |   |
| Total                         |       | $                                                   | 181.0      |                                             | 100.0      | % | $ | 179.1 |   | 100.0 | % | $ | 329.4 |   | 100.0 | % | $ | 335.8 |   | 100.0 | % |

 

**Three Months Ended June 30, 2006 Compared With the Three Months EndedJune 30, 2005**

*Sales*

Salesconsist of revenue from products delivered and services sold or rendered, netof allowances for customer returns. Sales for the second quarter of 2006increased $1.8 million, or 1.0%, compared to the same period in 2005. Thisincrease was related to large software deals booked during the quarter.Additionally, we were positively impacted by the closure of Northrup Grumman’sreseller business in terms of reduced competition and increased availability ofhuman capital resources in the tight labor market in the Washington DCmetropolitan area.  As we continue toimplement our strategy to move away from a volume focus towards deals that aremore profitable, we expect increasingly higher gross margins as a percentage ofsales.

Ananalysis of sales by type indicates sales of software increased $5.8 millionand services increased $3.5 million during the three months ended June 30,2006, compared to the three months ended June 30, 2005. These increases werepartially offset by the $5.1 million decline in hardware sales and the $2.3million decrease in sales of third party service products. The increase inservices sales and decrease in third-party provided services is consistent withour plans to become a high-end solutions provider. We achieved record saleswith our U.S. Communities contract, which was renewed in April 2006 for anadditional two years. As a result, management expects our sales to state and localgovernments to continue to increase as a percentage of our total sales.

Salesof Cisco increased $7.2 million quarter over quarter, accompanied by salesincreases from Sun and Microsoft of $3.4 million and $3.9 million,respectively.  These increases werepartially offset by declines

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insales from our Panasonic and HP vendors. Sales from our top five vendors increased $10.8 million and increased asa percentage of total sales from 56% to 61%, reflecting the results of ourfocused partner initiative. We expect total sales for the three months endingSeptember 30, 2006 to decrease over the three months ended September 30, 2005as we change our focus from revenue growth to higher gross margins to improvethe profitability of the Company.

*GrossMargin*

 

Grossmargin is sales less cost of sales, which includes product cost, freight,warranty maintenance cost and certain other expenses related to the cost ofacquiring products. Gross margin dollars increased $7.4 million, or 39.1%, from$19.1 million for the three month period ended June 30, 2005 to $26.5 millionfor the three months ended June 30, 2006. This increase was due to the $1.8million increase in sales and the decrease in cost of sales of $5.6 million.The cost of sales decrease was related to higher vendor incentive funds of $4.3million which are recorded as a reduction of cost of sales. Gross margin as apercentage of sales increased 4.0 percentage points to 14.6% in the secondquarter of 2006 from 10.6% in the second quarter of 2005. This increase was dueto margins contributed by the DOD sector of our business. Gross marginpercentages vary over time and may change significantly depending on ourcustomers’ use of available contract vehicles and the mix of products sold.

*Selling,General & Administrative Expenses*

 

Duringthe three months ended June 30, 2006, Selling, General & Administrative (“SG&A”)expenses decreased $1.3 million, or 4.6%, from the same period in 2005.  This decrease is primarily due to a $1.0million decrease in salary expense as a result of our reductions in workforce.  In addition, salary andconsultant costs decreased approximately $2 million quarter over quarter asmore labor was capitalized in connection with our next release of GEMS. Thesedecreases were partially offset by increases in commission expense of $1.2million due to higher total sales and higher margins on those sales.  SG&A expenses increased $0.3 million forstock-based compensation for stock options upon the adoption of FAS 123R and anincrease in restricted stock awards. Incentive expense increased $1.0 million over the same period of lastyear based on improved results during the second quarter of 2006.

Expressedas a percentage of total sales, SG&A expenses decreased from 15.9% duringthe three months ended June 30, 2005 to 15.0% for the same period of thecurrent year.  Management is committed toreducing our expenses to match our sales and gross margin forecasts.

*Interestand Other Income, Net*

 

Interestand other income, net, remained relatively flat period over period.  The increase in lease-related income duringthe three months ended June 30, 2006 was partially offset by a $2.3 millionincrease in interest and other expense due to increased fees to amend ourcredit facility and enter into a Forbearance Agreement prior to obtainingfinancing under our new Credit Agreement.

# **Six Months Ended June 30, 2006 Compared With theSix Months Ended June 30, 2005**

*Sales*

 

Salesfor the first six months of 2005 were $335.8 million, compared to $329.2million in the first six months of 2006, a decrease of $6.6 million, or1.9%.  Our year to date sales decline ispredominantly due to the $8.4 million decrease in first quarter sales relatedto weak performance associated with certain sales teams resulting in lower thanexpected bookings. This decline was partially offset during the second quarterby the increase in services sales.

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Ananalysis of sales by type indicates the overall sales decline of $6.5 millionperiod over period was related to the $18.2 million decrease in hardware,partially offset by the $12.9 million increase in services sales and the $2.6million increase in software sales. Our services sales increased approximately 161%period over period from $8.0 million for the six months ended June 30, 2005 to$20.9 million for the six months ended June 30, 2006. This increase waspredominantly due to significant growth in the professional services teamduring the past two years.  We entered 2006 with a very strong servicesbacklog and have grown the organization in 2006 to support the growth in sales.As one of the newest organizations in GTSI, we expect the professional servicesgroup to continue to have a strong growth rate in 2007.

*Gross Margin*

 

Despitethe decrease in sales, gross margin increased $8.4 million during the sixmonths ended June 30, 2006 as compared to the prior period. This improvementwas due to improved product mix, increased services revenue, and centralizedpricing initiatives implemented by management. Gross margin as a percentage ofsales increased 2.7% to 13.6% for the six months ended June 30, 2006.

*SG&A Expenses*

 

SG&Aexpenses for the six months ended June 30, 2006 remained relatively flat periodover period at approximately $56.7 million. SG&A expenses as a percentageof sales increased slightly to 17.2% for the six months ended June 30, 2006.During the six months ended June 30, 2006, SG&A expenses included a $1.2million severance expense under the terms of the transition agreement with ourformer CEO.  In addition, commissionexpense increased $1.7 million, despite the $6.5 million decrease in sales, dueto commissions paid on higher margins obtained during 2006.  SG&A expenses increased $0.6 million in2006 for stock-based compensation for our restricted stock awards and for stockoptions upon the adoption of FAS 123R. Incentive compensation expense increased $1.7 million and bad debtexpense increased $0.6 million during the first half of 2006 over the sameperiod of last year. The increase in incentive compensation expense wasprimarily related to the accrual for bonuses to our executive officers andother eligible employees in an effort to promote retention and performance in2006 and beyond. These increases were parially offset by decreases of $1.0million for training expenses and $1.7 million, or 6.5%, of salary expenses asa result of the reductions in workforce in October 2005 and February 2006.

*Income Taxes*

 

Ourincome tax benefit was $7.1 million for the six months ended June 30, 2005, atan effective tax rate of 37.7%.  As aresult of our full valuation allowance on our deferred tax assets, we did notreport any income tax benefit during the six months ended June 30, 2006,despite our $9.1 million loss before income taxes.

**Seasonal Fluctuations**

Historically, over 95% of our annual sales have beenearned from departments and agencies of the U.S. Federal Government, eitherdirectly or indirectly through system integrators to which GTSI is asub-contractor. We have historically experienced, and expect to continue toexperience, significant seasonal fluctuations in our operations as a result ofgovernment buying and funding patterns, which also affect the buying patternsof GTSI’s prime contractor customers.  Thesebuying and funding patterns historically have had a significant positive effecton our bookings in the third quarter ended September 30 each year (the Federalgovern­ment’s fiscal year end), and consequently on sales and net income in thethird and fourth quarters of each year.

Historically, sales during the first and secondquarters of our fiscal year have averaged approximately 17% and 21%,respectively, of our annual sales. However, we expect a change in this trend aswe focus more on profitability and less on top line sales.

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Our SG&A expenses are more level throughout theyear. Quarterly financial results are also affected by the timing of contractawards and the receipt of products by our customers.  The seasonality of our business, and theunpredictability of the factors affecting such seasonality, makes GTSI’squarterly and annual financial results difficult to predict and subject tosignificant fluctuation.

**Liquidityand Capital Resources**

*Cash flows for the six months ended June 30,*

| (in millions)                               | ** ** | **2006** | ** ** | **2005  (restated)** | ** ** | **Increase  (Decrease)** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------------------|------------|--------------------------|------------|
| Cash provided by  (used in) operating activities |       | $        | 23.8       |                 | $          | (8.9                     | )          | $ | 32.7 |   |
| Cash used in  investing activities               |       | $        | (1.3       | )                    | $          | (2.2                     | )          | $ | 0.9 |   |
| Cash (used in) provided  by financing activities |       | $        | (22.5      | )                    | $          | 11.0                     |       | $ | (33.5 | ) |

 

Duringthe six months ended June 30, 2006, current assets decreased $60.3 million whencompared to December 31, 2005. This decline is mainly due to decreasedaccounts receivable of $72.2 million as a result of our increased collectionsefforts during the first and second quarters of 2006. In addition, we reducedour inventory on hand by $5.2 million to mitigate our inventory risk and moreeffectively manage our cash flows.

Cashused in financing activities increased $33.4 million quarter over quarter,predominantly due to the higher outstanding balance under the Credit Facilityas of December 31, 2005 as compared to December 31, 2004.

*Liquidity*

 

Asof June 30, 2006, our working capital was $57.0 million, as compared to $60.2million for the same period in 2005. GTSI’s current assets are $64.4 millionless as of June 30, 2006 when compared to December 31, 2005. This declineis mainly due to decreased accounts receivable of $72.2 million related tolower 2006 sales, offset by increased prepaid expense of $13.6 million reportedin other current assets. These prepaid expenses are related to the feesassociated with obtaining financing which will be expensed over the term of ourCredit Agreement.

Ourtreasury stock is generally reissued upon exercise of employee stock optionsand for the employee stock purchase plan. No shares of common stock werepurchased during the six months ended June 30, 2006. As of June 30, 2006, wehad remaining authorization to purchase $5.1 million of GTSI’s common stockunder the plan modified by the Board of Directors in April 2005. However, theterms of our Credit Agreement restrict us from purchasing treasury stock until2010.

*CreditAgreements*

 

Weentered into a revolving credit agreement of $125 million on June 2, 2006 withSunTrust Bank and Bank of America, N.A. to provide a credit facility in anaggregate amount not to exceed $125 million (the “Credit Agreement”). ThisCredit Agreement replaced our former credit facility which expired on May 31,2006.

TheCredit Agreement provides access to capital through June 2, 2010 withborrowings secured by substantially all of GTSI’s assets. Borrowing under theCredit Agreement at any time is limited to the lesser of $125 million or acollateral-based borrowing base less outstanding obligations. The CreditAgreement subjects GTSI to certain covenants limiting its ability to (i) freelyincur debt; (ii) make certain guarantees; (iii) make certain restrictedpayments, purchases or investments; (iv) enter into specified

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transactionswith affiliates; (v) acquire real estate and (vii) enter into sales andleaseback transactions. The Credit Agreement carries an interest rate generallyindexed to the Prime Rate plus 25 basis points. The Credit Agreement containsnegative financial performance covenants, information covenants and certainaffirmative covenants. As of June 30, 2006, we were in compliance with allcovenants set forth in the Credit Agreement. As of June 30, 2006 our availablecredit under the Credit Agreement was $31.1 million.

OnJune 2, 2006, we also entered into a subordinated secured long-term loanagreement with Crystal Capital Fund, L.P. (the “Term Loan”) to provide anadditional $10 million of financing.  Theinterest rate on the Term Loan is Prime plus 5.0% per annum. This agreementcontains a prepayment penalty if we choose to repay the loan before one year.

Inanticipation of working capital requirements during the latter half of 2006, onJuly 13, 2006 we executed a First Amendment to the Credit Agreement to increasethe revolving credit agreement $10 million to $135 million and added severalbanks to the lender syndicate. Non-compliance with our covenants would allowthe creditors to accelerate the loan under certain conditions. On November 30,2006, GTSI executed a second amendment to the credit agreement to reviseseveral provisions contained in the Definitions, Interest, Minimum EBITDA andFixed Charge Coverage Ratio sections. In exchange for these financialaccommodations the Company agreed to make a one-time payment to each Lender inan amount to 0.15% of such Lender’s portion of the Revolving LoanCommitment.  On November 30, 2006, GTSIand its wholly owned subsidiaries also amended the Company’s Term Loan byentering into an amendment with the Lenders and Crystal Capital Fund, L.P.,under similar terms as the above referenced Second Amendment to the CreditAgreement.

*CapitalRequirements*

 

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. GTSI recorded a net loss of $9.1 million for the six months endedJune 30, 2006. Despite this fact, we were able to maintain positive cash flowfrom operations due to our intense collection efforts during the six monthsended June 30, 2006.  We anticipatethat we will continue to rely primarily on operating cash flow and our creditagreement to finance our operating cash needs.

Duringthe six months ended June 30, 2006 our obligations under letters of creditincreased $5.9 million to $7.8 million as a result of collateral for aperformance bond and a vendor line of credit, offset by the expiration of aletter of credit to a customer upon successful completion of a physicalsecurity project. We have no commitments to purchase inventory or equipment,nor do we have any off-balance sheet arrangements.

**New Accounting Pronouncements**

InJune 2006, the Financial Accounting Standards Board (“FASB”) issuedInterpretation No. 48 (“FIN 48”), *Accounting for Uncertaintyin Income Taxes,* which clarifies the accounting for uncertainty inincome taxes recognized in the financial statements in accordance with FASBStatement No. 109, *Accounting for IncomeTaxes*. FIN 48 provides guidance on the financial statement recognition,measurement, presentation and disclosure of uncertain tax positions taken orexpected to be taken in income tax returns. FIN 48 is effective for fiscalyears beginning after December 31, 2006. We are currently evaluating the impactof this standard on our consolidated financial statements.

InSeptember 2006, the FASB issued statement of Financial Accounting Standards (“SFAS”)No. 157, *Fair Value Measurement*, (“FAS 157”),which establishes a framework for measuring fair value in generally accepted accountingprinciples, and expands disclosures about fair value measurements. FAS 157 iseffective for interim periods beginning after November 15, 2007. We arecurrently evaluating the impact of this standard on our consolidated financialstatements.

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In September 2006, the SEC released SEC Staff Accounting Bulletin (“SAB”) No. 108,*Considering the Effects of Prior YearMisstatements when Quantifying Misstatements in Current Year FinancialStatements (“SAB 108”)*, which addresses how uncorrected errors inprevious years should be considered when quantifying errors in current yearfinancial statements and requires registrants to consider the effect of allcarry over and reversing effects of prior year misstatements when quantifyingerrors in current year financial statements. SAB 108 allows registrants torecord the effects of adopting the guidance as a cumulative effect adjustmentwhich must be reported as of the beginning of the first fiscal year endingafter November 15, 2006. The Company does not expect SAB 108 to have asignificant effect on the Company’s consolidated financial position or itsresults of operations.

**ITEM 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

GTSI had a $125 millionCredit Agreement indexed at Prime plus 25 basis points per annum and along-term loan of $10 million indexed at Prime plus five percent as of June 30,2006. These credit facilities expose 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 facilities. If interest rates increase, our debtservice obligations on the variable rate indebtedness would increase eventhough the amount borrowed remained the same, which would require more cash toservice our indebtedness. The effect of a 5% increase in interest rates wouldhave resulted in additional interest expense during the three months ended June30, 2006 of $0.1 million based on our average monthly balances. We have notused derivative instruments to alter the interest rate characteristics of ourborrowings. At June 30, 2006 we had $17.5 million of variable rate debt subjectto interest.

Included in our long-termdebt are amounts related to transferred receivables.  We have reported these amounts in Note 3 aslong-term financed lease debt.  Theseamounts will amortize over the period of the lease instruments with no cashaffect to the Company.  The balances ofthese liabilities were $14.1 million and $16.0 million at June 30, 2006 andDecember 31, 2005, respectively.  Achange in interest rates would result in no additional interest expense relatedto financed lease debt.

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**ITEM 4.   CONTROLS AND PROCEDURES**

**Evaluation of Disclosure Controls and Procedures**

An evaluation was carried out under the supervision and with theparticipation of our management including our Chief Executive Officer and ChiefFinancial Officer, of the effectiveness of the design and operation of ourdisclosure controls and procedures (as defined in Rules13a-15(e) or 15d-15(e)under the Securities Exchange Act of 1934, as amended) as of June 30,2006.  Our disclosure controls andprocedures are designed to (i) ensure that information required to be disclosedby us in reports we file or submit under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission’s rules and forms and (ii) is accumulatedand communicated to GTSI’s management including our principal executive officerand our principal financial officer, as appropriate to allow timely decisionsregarding required disclosures.  Based onthis evaluation, our Chief Executive Officer and Chief Financial Officerconcluded that our disclosure controls and procedures were not effective as ofJune 30, 2006.  

**Changes in Internal Control Over Financial Reporting and Management’sRemediation Initiatives**

During management’s assessment of the effectiveness of our internalcontrol over financial reporting as of December 31, 2005, we identified fivematerial weaknesses, which are described in Item 9A of our Annual Report onForm 10-K/A for the year ended December 31, 2005. We are currently makingprogress as described below on our planned remediation actions and expect tofinalize them by mid-2007. 

With respect to increasing the size, expertise and training of thefinance and accounting staff to include adequate resources for ensuring GAAPcompliance, we continued to hire consultants to supplement our remainingopenings while we continue our active personnel searches in the revenuerecognition and general ledger accounting functions. 

In regards to our remediation plan for upgrading the capabilities ofcertain staff in existing finance and accounting positions to improve theoverall quality and integrity of record keeping and financial reporting,certain members of accounting management attended training relevant to theachievement of those objectives.

Withrespect to ensuring that the purchasing, order fulfillment and customer servicedepartments are appropriately staffed and trained, several permanent positionshave been filled including the newly created Inventory Control Supervisor position.In addition, we are conducting active searches for the remaining openings andare supplementing with consultants. We plan to continue to use externalresources until the hiring and training of permanent staff is completed. 

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**PART II.  OTHER INFORMATION**

**ITEM 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS**

(a)           The Company held its annual meetingof stockholders on May 09, 2006.

(b)           Set forth below is the matter that was presented to and voted upon bythe Company’s stockholders, and the results of such stockholders’ votes.

Election ofDirectors

|                 | ** ** | ** ** | ** ** | **Votes**          | ** ** |
|-----------------|------------|------------|------------|--------------------|------------|
| **Nominees**    | ** ** | ** ** | ** ** | **Votes For** | ** ** | **Withheld** | ** ** |
| Steven Kelman   |       | 7,813,379  |       | 50,645             |       |
| Barry L. Reisig |       | 7,503,510  |       | 360,514            |       |
| John M. Toups   |       | 7,503,260  |       | 360,764            |       |
|                 |            |            |            |                    |            |  |  |

** **

**ITEM 6.  EXHIBITS**

The exhibits set forth inthe Exhibit Index are filed as part of this Quarterly Report on Form 10-Q.

**SIGNATURES**

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on December 22, 2006 onits behalf by the undersigned thereunto duly authorized.
|            | ** ** | **GTSI Corp.**                                    |
|------------|------------|---------------------------------------------------|
| ** ** | ** ** | ** **                                        |
| ** ** | ** ** | ** **                                        |
|       |       | /s/ JAMES J. LETO                                 |
|       |       | James J. Leto                                     |
|       |       | President and Chief Executive Officer             |
|       |       |                                              |
|       |       |                                              |
|       |       | /s/ JOE RAGAN                                     |
|       |       | Joe Ragan                                         |
|       |       | Senior Vice President and Chief Financial Officer |

 

 

26

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**EXHIBIT INDEX**
| Exhibit    | ** ** | ** **                                                                                                                    |
|------------|------------|-------------------------------------------------------------------------------------------------------------------------------|
| **Number** | ** ** | **Description**                                                                                                               |
| 10.1       |       | Credit Agreement dated as of June 2, 2006 between  GTSI Corp., SunTrust Bank and Bank of America (1)                          |
| 10.2       |       | Credit Agreement dated as of June 2, 2006 between  GTSI Corp., and Crystal Capital Fund, L.P. (1)                             |
| 10.3       |       | First Amendment to Credit Agreement dated as of July  13, 2006 between GTSI Corp., SunTrust Bank and Bank of America (2)      |
| 10.4       |       | First Amendment to Credit Agreement dated as of July  13, 2006 between GTSI Corp. and Crystal Capital Fund, L.P. (2)          |
| 10.5       |       | Second Amendment to Credit Agreement dated as of  November 30, 2006 between GTSI Corp., SunTrust Bank and Bank of America (3) |
| 10.6       |       | Second Amendment to Credit Agreement dated as of  November 30, 2006 between GTSI Corp. and Crystal Capital Fund, L.P. (3)     |
| 31.1       |       | Section 302 Certification of Chief Executive Officer  (filed herewith)                                                        |
| 31.2       |       | Section 302 Certification of Chief Financial Officer  (filed herewith)                                                        |
| 32         |       | Section 906 Certification of Chief Executive Officer  and Chief Financial Officer (filed herewith)                            |

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(1)             Incorporatedby reference to the Registrant’s current report on Form 8-K dated June 2, 2006.

(2)             Incorporatedby reference to the Registrant’s current report on Form 8-K dated July 13,2006.

(3)             Incorporatedby reference to the Registrant’s current report on Form 8-K dated December 5,2006.

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