**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

**FORM 10–Q**

 

**QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGEACT OF 1934**

 

**For thequarterly period ended September 30, 2005**

 

**CommissionFile 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)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe 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 tosuch filing requirements for the past 90 days.          YES ý        NO  o

 

Indicateby check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act).  YESý   NO  o

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act). YESo   NO  ý

 

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date:

 

| **Class**                      | ** ** | **Shares Outstanding at October 31, 2005** | ** ** |
|--------------------------------|------------|-------------------------------------------------|------------|
| Common Stock, $0.005 par value |       | 9,277,532                                       |       |

 

 

----

 

**GTSICORP.**

**Form 10–Qfor the Quarter Ended September 30, 2005**

 

**INDEX**

 
| **PART I – FINANCIAL INFORMATION** |                                                                                                                     |
|----------------------------------------------|--------------------------------------------------------------------------------------------------------------------------|
|                                         |                                                                                                                     |   |
| ITEM 1.                                      | FINANCIAL STATEMENTS –                                                                                              |   |
|                                         |                                                                                                                     |   |
|                                         | Consolidated  Balance Sheets as of September 30, 2005 (Unaudited) and  December 31, 2004                       |   |
|                                         |                                                                                                                     |   |
|                                         | Consolidated  Statements of Operations for the Three and Nine Months Ended  September 30, 2005 and 2004 (Unaudited) |   |
|                                         |                                                                                                                     |   |
|                                         | Condensed  Consolidated Statements of Cash Flows for the Nine Months Ended  September 30, 2005 and 2004 (Unaudited) |   |
|                                         |                                                                                                                     |   |
|                                         | Notes  to Condensed Consolidated Financial Statements (Unaudited)                                                        |   |
|                                         |                                                                                                                     |   |
| ITEM  2.                                     | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                              |   |
|                                         |                                                                                                                     |   |
| ITEM  3.                                     | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                              |   |
|                                         |                                                                                                                     |   |
| ITEM 4.                                      | CONTROLS AND PROCEDURES                                                                                                  |   |
|                                         |                                                                                                                     |   |
| **PART II – OTHER INFORMATION**    |                                                                                                                     |
|                                         |                                                                                                                     |   |
| ITEM 1.                                      | LEGAL  PROCEEDINGS                                                                                                       |   |
|                                         |                                                                                                                     |   |
| ITEM  2.                                     | UNREGISTERED  SALES OF EQUITY SECURITIES, USE OF PROCEEDS, AND ISSUER PURCHASES OF EQUITY  SECURITIES                    |   |
|                                         |                                                                                                                     |   |
| ITEM 6.                                      | EXHIBITS                                                                                                                 |   |
|                                         |                                                                                                                     |   |
| **SIGNATURES**                               |                                                                                                                     |
|                                         |                                                                                                                     |   |
| **EXHIBIT INDEX**                       |                                                                                                                     |

 

1

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**PART I. FINANCIAL INFORMATION**

 

**ITEM 1.****     FINANCIALSTATEMENTS**

 

**GTSI CORP.**

**CONSOLIDATED BALANCE SHEETS**

(In thousands, except share data)

 
| ** **                                                                                                                                                                                                        | ** ** | **(Unaudited)**        | ** ** | ** **            | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                        | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| ** **                                                                                                                                                                                                        | ** ** | **2005**               | ** ** | **2004**              | ** ** |
| **ASSETS**                                                                                                                                                                                                        | ** ** | ** **             | ** ** | ** **            | ** ** |
| Current assets:                                                                                                                                                                                                   | ** ** | ** **             | ** ** | ** **            | ** ** |
| Cash                                                                                                                                                                                                              |       | $                      | 45         |                  | $          | 397 |   |
| Accounts  receivable, net                                                                                                                                                                                         |       | 213,519                |       | 202,742               |       |
| Leases  receivable, net                                                                                                                                                                                           |       | 12,586                 |       | 7,864                 |       |
| Merchandise  inventories                                                                                                                                                                                          |       | 80,307                 |       | 59,184                |       |
| Other current  assets                                                                                                                                                                                             |       | 17,994                 |       | 9,616                 |       |
| Total current  assets                                                                                                                                                                                             |       | 324,451                |       | 279,803               |       |
| Property and  equipment, net                                                                                                                                                                                      |       | 4,091                  |       | 5,083                 |       |
| Computer  software, net                                                                                                                                                                                           |       | 11,100                 |       | 10,100                |       |
| Other assets                                                                                                                                                                                                      |       | 5,411                  |       | 1,400                 |       |
| Total assets                                                                                                                                                                                                      |       | $                      | 345,053    |                  | $          | 296,386 |   |
|                                                                                                                                                                                                              |       |                   |       |                  |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                    |       |                   |       |                  |       |
| Current  liabilities:                                                                                                                                                                                             |       |                   |       |                  |       |
| Notes payable to  banks                                                                                                                                                                                           |       | $                      | —     |                  | $          | 1,179 |   |
| Accounts payable                                                                                                                                                                                                  |       | 227,310                |       | 173,218               |       |
| Accrued liabilities                                                                                                                                                                                               |       | 14,333                 |       | 14,734                |       |
| Deferred revenue                                                                                                                                                                                                  |       | 15,526                 |       | 9,216                 |       |
| Accrued warranty  liabilities                                                                                                                                                                                     |       | 1,011                  |       | 2,429                 |       |
| Total current  liabilities                                                                                                                                                                                        |       | 258,180                |       | 200,776               |       |
| Other  liabilities                                                                                                                                                                                                |       | 3,163                  |       | 3,473                 |       |
| Total  liabilities                                                                                                                                                                                                |       | 261,343                |       | 204,249               |       |
|                                                                                                                                                                                                              |       |                   |       |                  |       |
| Commitments and  contingencies                                                                                                                                                                                    |       |                   |       |                  |       |
|                                                                                                                                                                                                              |       |                   |       |                  |       |
| Stockholders’  equity                                                                                                                                                                                        |       |                   |       |                  |       |
| Common stock -  $0.005 par value, 20,000,000 shares authorized; 9,806,084 issued and  9,199,832 outstanding at September 30, 2005; and 9,806,084 issued and 8,987,643  outstanding at December 31, 2004 |       | 49                     |       | 49                    |       |
| Capital in  excess of par value                                                                                                                                                                                   |       | 46,266                 |       | 46,817                |       |
| Retained  earnings                                                                                                                                                                                                |       | 41,743                 |       | 50,395                |       |
| Treasury stock,  606,252 shares at September 30, 2005 and 818,441 shares at  December 31, 2004, at cost                                                                                                 |       | (4,348                 | )          | (5,124                | )          |
| Total  stockholders’ equity                                                                                                                                                                                  |       | 83,710                 |       | 92,137                |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                                  |       | $                      | 345,053    |                  | $          | 296,386 |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

2

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**GTSI CORP.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

(Unaudited)

(In thousands, except per share data)

 
| ** **                                          | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                          | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                |       |                                       |       |                                      |       |   |   |   |   |
| SALES                                               |       | $                                          | 287,708    |                                      | $          | 330,645 |   | $ | 605,392 |   | $ | 748,257 |   |
|                                                |       |                                       |       |                                      |       |   |   |   |   |
| COST OF SALES                                       |       | 252,594                                    |       | 283,922                                   |       | 535,593 |   | 661,915 |   |
|                                                |       |                                       |       |                                      |       |   |   |   |   |
| GROSS MARGIN                                        |       | 35,114                                     |       | 46,723                                    |       | 69,799 |   | 86,342 |   |
|                                                |       |                                       |       |                                      |       |   |   |   |   |
| SELLING, GENERAL & ADMINISTRATIVE EXPENSES |       | 31,897                                     |       | 30,404                                    |       | 88,596 |   | 76,723 |   |
|                                                |       |                                       |       |                                      |       |   |   |   |   |
| INCOME (LOSS) FROM OPERATIONS                       |       | 3,217                                      |       | 16,319                                    |       | (18,797 | ) | 9,619 |   |
|                                                |       |                                       |       |                                      |       |   |   |   |   |
| INTEREST AND OTHER INCOME                           |       |                                       |       |                                      |       |   |   |   |   |
| Interest and  other income                          |       | 4,741                                      |       | 1,021                                     |       | 6,146 |   | 2,931 |   |
| Interest and  other expense                         |       | (452                                       | )          | (63                                       | )          | (764 | ) | (122 | ) |
| Interest and  other income, net                     |       | 4,289                                      |       | 958                                       |       | 5,382 |   | 2,809 |   |
|                                                |       |                                       |       |                                      |       |   |   |   |   |
| INCOME (LOSS) BEFORE INCOME TAXES                   |       | 7,506                                      |       | 17,277                                    |       | (13,415 | ) | 12,428 |   |
|                                                |       |                                       |       |                                      |       |   |   |   |   |
| INCOME TAX PROVISION (BENEFIT)                      |       | 2,837                                      |       | 6,823                                     |       | (4,763 | ) | 4,909 |   |
|                                                |       |                                       |       |                                      |       |   |   |   |   |
| NET INCOME (LOSS)                                   |       | $                                          | 4,669      |                                      | $          | 10,454 |   | $ | (8,652 | ) | $ | 7,519 |   |
|                                                |       |                                       |       |                                      |       |   |   |   |   |
| EARNINGS (LOSS) PER SHARE                           |       |                                       |       |                                      |       |   |   |   |   |
| Basic                                               |       | $                                          | 0.50       |                                      | $          | 1.21 |   | $ | (0.94 | ) | $ | 0.88 |   |
| Diluted                                             |       | $                                          | 0.49       |                                      | $          | 1.13 |   | $ | (0.94 | ) | $ | 0.80 |   |
|                                                |       |                                       |       |                                      |       |   |   |   |   |
| WEIGHTED AVERAGE SHARES OUTSTANDING                 |       |                                       |       |                                      |       |   |   |   |   |
| Basic                                               |       | 9,262                                      |       | 8,646                                     |       | 9,172 |   | 8,592 |   |
| Diluted                                             |       | 9,522                                      |       | 9,255                                     |       | 9,172 |   | 9,355 |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

3

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**GTSI CORP.**

**CONDENSEDCONSOLIDATED STATEMENTS OF CAS****H FLOWS**

(Unaudited)

(In thousands)

 
| ** **                                                                               | ** ** | **Nine months ended**  | ** ** |
|------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                               | ** ** | **September 30,** | ** ** |
| ** **                                                                               | ** ** | **2005**               | ** ** | **2004** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                                | ** ** | ** **             | ** ** | ** ** | ** ** |
| Net (loss) income                                                                        |       | $                      | (8,652     | ) | $ | 7,519 |   |
| Adjustments to reconcile net (loss) income to net  cash provided by operating activities |       | 13,212                 |       | 9,455 |   |
| Net cash provided  by operating activities                                               |       | 4,560                  |       | 16,974 |   |
|                                                                                     |       |                   |       |   |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                                |       |                   |       |   |   |
| Cost of software and equipment                                                           |       | (3,057                 | )          | (5,699 | ) |
| Net cash used in  investing activities                                                   |       | (3,057                 | )          | (5,699 | ) |
|                                                                                     |       |                   |       |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                                |       |                   |       |   |   |
| Payments of bank notes, net                                                              |       | (1,179                 | )          | (12,813 | ) |
| Payments to acquire treasury stock                                                       |       | (2,990                 | )          | — |   |
| Proceeds from ESPP                                                                       |       | 247                    |       | 430 |   |
| Proceeds from exercises of stock options                                                 |       | 2,067                  |       | 1,067 |   |
| Net cash used in  financing activities                                                   |       | (1,855                 | )          | (11,316 | ) |
|                                                                                     |       |                   |       |   |   |
| NET DECREASE IN CASH                                                                     |       | (352                   | )          | (41 | ) |
| CASH AT BEGINNING OF PERIOD                                                              |       | 397                    |       | 177 |   |
| CASH AT END OF PERIOD                                                                    |       | $                      | 45         |   | $ | 136 |   |
|                                                                                     |       |                   |       |   |   |
| CASH PAID DURING THE PERIOD FOR:                                                         |       |                   |       |   |   |
| Interest                                                                                 |       | $                      | 437        |   | $ | 117 |   |
| Income taxes                                                                             |       | $                      | 30         |   | $ | 1,018 |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

4

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**GTSI CORP.**

**NOTESTO CONDENSED CONSOLIDATED FINANCIA****L STATEMENTS**

(Unaudited)

 

**1.  Basis of Presentation**

 

Theaccompanying unaudited interim condensed consolidated financial statements ofGTSI Corp. and its wholly owned subsidiaries (“GTSI” or the “Company”) havebeen prepared pursuant to the rules and regulations of the Securities andExchange Commission (“SEC”) for quarterly reports on Form 10-Q and,therefore, omit or condense certain note disclosures and other informationrequired by accounting principles generally accepted in the United States ofAmerica for complete financial statements. These financial statements should therefore be read in conjunction withthe audited consolidated financial statements and accompanying notes for theyear ended December 31, 2004 included in GTSI’s Annual Report on Form 10-K,as amended by Forms 10-K/A filed with the SEC on April 28, 2005 and August 1,2005.

 

Investmentsin which the Company does not control the investee but has the ability toexercise significant influence over its operating and financial policies areaccounted for using the equity method of accounting. In the opinion ofmanagement, the accompanying unaudited condensed consolidated financialstatements reflect all adjustments of a normal recurring nature (except asdisclosed herein) considered necessary to present fairly GTSI’s financialposition as of September 30, 2005 and December 31, 2004, its resultsof operations for the three and nine months ended September 30, 2005 and2004, and its cash flows for the nine months ended September 30, 2005 and2004.

 

Theresults of operations for the three and nine month periods ended September 30,2005 are not necessarily indicative of the results that may be expected for thefull year, or future periods. GTSI has historically experienced significantseasonal fluctuations in operations as a result of government buying andfunding patterns. These patterns historically have had a positive effect onGTSI’s sales and net income during the quarter ended September 30 (theFederal government’s fiscal year end). Certain prior period amounts have beenreclassified to conform to the current period presentation.

 

**2. NewAccounting Pronouncements**

 

InDecember 2004, the Financial Accounting Standards Board (“FASB”) issued Statementof Financial Accounting Standards (“SFAS”) No. 123 (Revised 2004)“Share-Based Payment” (“FAS 123R”), which is a revision of FASB Statement No. 123,“Accounting for Stock-Based Compensation” (“FAS 123”). FAS 123R supersedes AccountingPrinciples Board Opinion (“APB”) No. 25, “Accounting for Stock Issued toEmployees” (“APB 25”) and its related Interpretations. Generally, the approachto accounting in FAS 123R requires all share-based payments to employees,including grants of employee stock options, to be recognized in the statements ofoperations based on the grant-date fair value of the award.

 

Aspermitted by FAS 123, the Company currently accounts for share-based paymentsto employees using the intrinsic value provisions of APB 25 and, as such,generally recognizes no compensation costs for employee stock options.Accordingly, the adoption of FAS 123R’s fair value method may have a significantimpact on the Company’s results of operations. The impact of the adoption ofFAS 123R cannot be predicted at this time because it will depend on levels ofshare-based payments granted in the future. However, had the Company adoptedFAS 123R in prior periods, the impact would have approximated the impact of FAS123 as described in the disclosure of pro forma net income and earnings

 

5

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pershare in Note 3 of these condensed consolidated financial statements. FAS123Ralso requires the benefits of tax deductions in excess of recognizedcompensation cost to be reported as a financing cash flow, rather than as anoperating cash flow as required under current literature. This requirement willreduce cash flows from operating activities and increase cash flows fromfinancing activities in periods after adoption.

 

InApril 2005, the SEC adopted a new rule that amends the compliancedate for FAS 123R to be effective as of the beginning of the first annualreporting period that begins after June 15, 2005. Thus, GTSI will adoptthe standard beginning January 1, 2006. FAS 123R offers severalalternatives for implementation.  At thistime, management plans to use the modified prospective transition method. TheCompany is also evaluating the impact of FAS 123R to GTSI’s employee stockpurchase plan.

 

InJune 2005, the FASB issued SFAS No. 154 “Accounting Changes and ErrorCorrections,” (“FAS 154”) which is a replacement of APB Opinion No. 20“Accounting Changes” and FASB Statement No. 3 “Reporting AccountingChanges in Interim Financial Statements”. FAS 154 changes the accounting forand reporting of changes in accounting principles and error corrections byrequiring retrospective application to prior period financial statements unlessimpracticable. This statement is effective in fiscal years beginning after December 15,2005 and the Company plans to adopt FAS 154 on January 1, 2006. TheCompany does not expect the adoption of FAS 154 to have a significant impact onits financial statements.

 

**3.  Stock-Based Compensation**

 

TheCompany accounts for stock-based compensation using the intrinsic value methodof accounting in accordance with APB 25 and related Interpretations.Accordingly, no compensation cost for stock options granted to employees wasreflected in net income, as all options granted had an exercise price equal tothe fair market value of the Company’s common stock on the date of the grant.The following table illustrates, in accordance with the provisions of SFAS No. 148“Accounting for Stock-Based Compensation – Transition and Disclosure” theeffect on net income and earnings per share if compensation costs for theCompany’s stock options had been determined based on the fair value methodconsistent with the provisions of FAS 123 (in thousands, except per sharedata):

 
| ** **                                                                                                                                    | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                                                    | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income (loss) – as reported                                                                                                          |       | $                                          | 4,669      |                                      | $          | 10,454 |   | $ | (8,652 | ) | $ | 7,519 |   |
| Deduct: Total  stock-based employee compensation expense determined under fair value based  method for all awards, net of related tax effects |       | (368                                       | )          | (449                                      | )          | (1,262 | ) | (1,314 | ) |
| Net income (loss) – pro forma                                                                                                            |       | $                                          | 4,301      |                                      | $          | 10,005 |   | $ | (9,914 | ) | $ | 6,205 |   |
|                                                                                                                                          |       |                                       |       |                                      |       |   |   |   |   |
| Earnings (loss) per share – as reported                                                                                                  |       |                                       |       |                                      |       |   |   |   |   |
| Basic                                                                                                                                         |       | $                                          | 0.50       |                                      | $          | 1.21 |   | $ | (0.94 | ) | $ | 0.88 |   |
| Diluted                                                                                                                                       |       | $                                          | 0.49       |                                      | $          | 1.13 |   | $ | (0.94 | ) | $ | 0.80 |   |
|                                                                                                                                          |       |                                       |       |                                      |       |   |   |   |   |
| Earnings (loss) per share – pro forma                                                                                                    |       |                                       |       |                                      |       |   |   |   |   |
| Basic                                                                                                                                         |       | $                                          | 0.46       |                                      | $          | 1.16 |   | $ | (1.08 | ) | $ | 0.72 |   |
| Diluted                                                                                                                                       |       | $                                          | 0.45       |                                      | $          | 1.06 |   | $ | (1.08 | ) | $ | 0.65 |   |

 

6

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Duringthe nine months ended September 30, 2005 and 2004, the Company recordedstock compensation expense of $34 thousand and $480 thousand, respectively, forstock options granted to non-employees based on the fair value method. Noexpense was incurred for stock options to non-employees during the three monthsended September 30, 2005 or 2004.

 

**4.  Leases Receivable**

 

TheCompany sells products to certain customers under sales-type lease arrangementstypically for terms of two or three years. The Company accounts for its sales-type leases according to theprovisions of SFAS No. 13 “Accounting for Leases” and, accordingly,recognizes current and long-term leases receivable, net of unearned financeincome, on the accompanying balance sheets. GTSI typically sells leases receivable to various unrelated financingcompanies and accounts for these sales in accordance with SFAS No. 140“Accounting for the Transfers and Servicing of Financial Assets andExtinguishments of Liabilities – a Replacement of FASB Statement 125.” The saleof leases receivable results in lease interest income recorded as non-operatingincome in the statement of operations. During the nine months ended September 30,2005, $49.1 million of leases receivable were sold to unrelated third-partyfinancing companies.

 

**5.  Inventory**

 

Merchandiseinventories are valued at the lower of cost or market. Cost is determined usinga weighted average method. During the three months ended September 30,2005, the Company recorded a $0.6 million reserve for obsolete inventory, whichis included in cost of sales.

 

Duringthe third quarter of 2004, GTSI recorded a charge of approximately $0.7 millionin Cost of Sales for the loss of inventory and filed a comprehensive claim withits insurance carrier.  The Companysubsequently received proceeds of $0.6 million from the insurance settlementduring the fourth quarter of 2004, resulting in a net charge to Cost of Salesin 2004 of $0.1 million related to this inventory loss.

 

During2004, certain integrated hardware components were discovered missing from anorder delivered to a customer. Although the investigation of this matter hasbeen essentially completed, the Company’s management was unable to determinewhere or when the loss occurred in the supply chain. GTSI recorded a charge ofapproximately $0.6 million in cost of sales during the fourth quarter of 2004and filed a comprehensive claim with its insurance carrier. Managementcurrently believes that it is remote that the Company will receive payment forits claim. No gain contingency amounts have been recorded as of September 30,2005.

 

**6.  Capitalized Software**

 

Capitalizedsoftware is stated at cost less accumulated amortization. On April 18, 2005GTSI replaced its legacy fulfillment system by implementing the supply chainmanagement modules of GTSI’s Enterprise Management System (“GEMS”). As of September 30,2005, the Company had capitalized $11.3 million of costs related to GEMS. Approximately$1.8 million was capitalized in the nine month period ended September 30,2005. Amortization expense for GEMS during the nine months ended September 30,2005 and September 30, 2004 was $0.8 million and $0.2 million,respectively.

 

7

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**7.  Accounts Payable**

 

SFASNo. 140 “Accounting for Transfers and Servicing of Financial Assets andExtinguishments of Liabilities,” states that the judicial release from anobligation results in the extinguishment of a liability. Upon the expiration ofthe statute of limitations in 2004, GTSI was judicially released fromobligations which resulted in the Company derecognizing $10.1 million in agedaccrued payables during the third quarter of 2004. The impact to GTSI’s financialresults for the three and nine months ended September 30, 2004 was anon-cash increase to gross margin of $10.1 million and an increase to netincome of $6.1 million after taxes were applied. The per share affect of thisextinguishment was $0.66 and $0.65 per diluted share for the three and ninemonths ended September 30, 2004, respectively.

 

**8.  Credit Facility**

 

AtSeptember 30, 2005 the Company had a $135 million revolving line of creditwith a group of lenders (the “Credit Facility”). During 2005, three amendmentsto the Credit Facility were executed predominantly to change the amount of theCredit Facility, add lenders to the lender syndicate, obtain waivers of certaincovenant defaults and modify the covenants applicable for the remainder of 2005.The Credit Facility includes a revolving line of credit (the “Revolver”) and aprovision for inventory financing of vendor products. The Credit Facility,unless terminated earlier, will continue after the maturity date of February 28,2006 unless any party gives the other party written notice of termination notless than 90 days prior to the start of a new renewal period.

 

Borrowing under the Revolveris limited to 85% of eligible accounts receivable. Borrowing under the CreditFacility is secured by substantially all of the Company’s assets. The Revolver carriesan interest rate indexed to the London Interbank Offered Rate (“LIBOR”) plus1.75 percentage points.

 

TheCredit Facility contains certain covenants relating to the maintenance ofcertain financial ratios and the operations of the Company. These covenantsinclude, among other restrictions, limitations upon the purchase of GTSI’sstock and prohibit the Company from paying cash dividends on its stock duringthe period from August 8, 2005 through December 31,2005.  The Company has never paid any cash dividends and does notanticipate paying cash dividends on its common stock in the foreseeable future.Payments for additional purchases of GTSI’s shares during the fourth quarter of2005 are restricted to a maximum of $1.9 million. At September 30, 2005,GTSI was in compliance with all financial covenants set forth in the CreditFacility and had available credit of $8.3 million at September 30, 2005and $59.1 million at December 31, 2004.

 

**9.  Stockholders’ Equity**

 

*Treasurystock*

During2005, GTSI’s Board of Directors approved a $7.3 million increase to the Company’sshare repurchase program. During the three months ended September 30,2005, the Company purchased approximately 213 thousand shares of common stockfor its treasury at a cost of $1.7 million. During the nine months ended September 30,2005, the Company purchased approximately 374 thousand shares of common stockfor $3.0 million. No purchases occurred during 2004. As of September 30,2005, GTSI had authorization for remaining future repurchases of $7.0 million. However,under the terms of our Credit Facility, purchases of GTSI common stock duringthe fourth quarter are restricted to $1.9 million.

 

*StockOptions*

During the nine months ended September 30, 2005and the year ended December 31, 2004, 500,700 and

 

8

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397,492, respectively, of stock options wereexercised under the Company’s stock option plan. These shares were issued fromtreasury stock. The tax benefit of stock options exercised during the ninemonths ended September 30, 2005 and 2004 was approximately $0.8 millionand $0.5 million, respectively.

 

*Restricted Stock*

Duringthe three months ended September 30, 2005, the Board of Directors approvedan annual program for stock-based compensation to improve retention of keyemployees. Recipients are given a choice of receiving stock option awards orrestricted stock grants at a 3:1 conversion rate. As a result, 23,333 shares ofrestricted stock were issued on July 21, 2005. These shares are scheduledto vest on the third, fourth, and fifth anniversaries of the grant date inequal installments. The Company recorded $189 thousand in stockholders’ equityfor deferred compensation during the three months ended September 30,2005.

 

Inaddition to the grants detailed above, during the nine months ended September 30,2005, the Company, as authorized by its Board of Directors, issued restrictedstock grants of 26,664 shares of the Company’s common stock to the non-employeemembers of the Board under the Amended and Restated 1996 Stock Incentive Plan. Theserestricted shares are scheduled to vest on June 10, 2006. The Companyrecorded $218 thousand as deferred compensation in the second quarter of2005.  No restricted stock was issuedduring 2004.

 

TheCompany recorded $407 thousand in stockholders’ equity for deferredcompensation during the nine months ended September 30, 2005. Deferredcompensation is amortized on a straight-line basis over the vesting period ofthe grants. During the three and nine months ended September 30, 2005, $59thousand and $77 thousand, respectively, was recorded as stock compensationexpense for restricted stock.

 

**10.  Vendor Rebates**

 

TheCompany has non-binding agreements to participate in a number of vendor rebateand sales volume attainment incentive programs. One of these programs provides that if a certain level of sales isobtained during the period August 1, 2005 to October 31, 2005, theCompany will receive a rebate from the vendor for a percentage of the sales.Although management believed, based on the Company’s performance during August andSeptember, that attainment of the required sales volume by the end of October wasprobable, pursuant to the revenue recognition guidelines in Staff AccountingBulletin No. 104 “Revenue Recognition,” no amounts were accrued in thefinancial statements as of September 30, 2005 due to the non-bindingnature of the program. If the Company meets the applicable requirements of theprogram, a vendor rebate of approximately $2.2 million will be recorded in thefourth quarter as a reduction of cost of sales for sales volumes attainedduring August and September of 2005. During the third quarter of2004, this vendor incentive program provided for rebates based on monthly salesattainment goals.

 

**11.  Earnings Per Share**

 

Basicearnings per share are calculated by dividing net income or loss by theweighted average shares outstanding during the period.  Diluted earnings per share are computedsimilarly to basic earnings per share, except that the weighted average sharesoutstanding are increased to include equivalents, when their effect isdilutive.

 

TheCompany excludes equity instruments from the calculation of diluted weightedaverage shares outstanding if the effect of including such instruments isantidilutive to earnings per share. Accordingly certain employee stock optionsand restricted stock shares totaling 673 thousand for the nine month

 

9

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periodended September 30, 2005 have been excluded. The following table setsforth the computation of basic and diluted earnings per share (in thousands,except per share amounts):

 
| ** **                          | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                          | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Numerator:                          |       |                                       |       |                                      |       |   |   |   |   |
| Net income  (loss)                  |       | $                                          | 4,669      |                                      | $          | 10,454 |   | $ | (8,652 | ) | $ | 7,519 |   |
|                                |       |                                       |       |                                      |       |   |   |   |   |
| Denominator:                        |       |                                       |       |                                      |       |   |   |   |   |
| Weighted average shares outstanding |       |                                       |       |                                      |       |   |   |   |   |
| Basic                               |       | 9,262                                      |       | 8,646                                     |       | 9,172 |   | 8,592 |   |
| Effect of  dilutive securities      |       | 260                                        |       | 609                                       |       | N/A |   | 763 |   |
| Diluted                             |       | 9,522                                      |       | 9,255                                     |       | 9,172 |   | 9,355 |   |
|                                |       |                                       |       |                                      |       |   |   |   |   |
| Net earnings (loss) per share:      |       |                                       |       |                                      |       |   |   |   |   |
| Basic                               |       | $                                          | 0.50       |                                      | $          | 1.21 |   | $ | (0.94 | ) | $ | 0.88 |   |
| Diluted                             |       | $                                          | 0.49       |                                      | $          | 1.13 |   | $ | (0.94 | ) | $ | 0.80 |   |

 

**12.  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. If actual product failure rates or servicedelivery costs differ from estimates, revisions to the estimated warrantyreserve would be required. The following table summarizes the activity relatedto product warranty liabilities (in thousands):

 
| ** **                                | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                | ** ** | **2005**                                  | ** ** | **2004** | ** ** |
| Accrued warranties at beginning of period |       | $                                         | 2,429      |   | $ | 4,555 |   |
| Charges made against warranty liabilities |       | (989                                      | )          | (1,829 | ) |
| Adjustments to warranty reserves          |       | (612                                      | )          | — |   |
| Accruals for additional warranties sold   |       | 183                                       |       | 1,471 |   |
| Accrued warranties at end of period       |       | $                                         | 1,011      |   | $ | 4,197 |   |

 

Revenuefrom extended warranty contracts is recorded as deferred revenue andsubsequently recognized over the term of the contract.  The following table summarizes the activityrelated to the deferred warranty revenue (in thousands):

 
| ** **                                       | ** ** | **Nine months ended  September 30,** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                       | ** ** | **2005**                                  | ** ** | **2004** | ** ** |
| Deferred warranty revenue at beginning of period |       | $                                         | 2,599      |   | $ | 2,819 |   |
| Deferred warranty revenue recognized             |       | (1,072                                    | )          | (1,025 | ) |
| Revenue deferred for additional warranties sold  |       | 102                                       |       | 862 |   |
| Deferred warranty revenue at end of period       |       | $                                         | 1,629      |   | $ | 2,656 |   |

 

10

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*Contingencies*

InDecember 2004, the Company became aware that a potential payroll taxliability existed for employees working in GTSI’s office in Germany. Managementdetermined that a tax liability was probable and accrued approximately $0.8million in accrued liabilities.  Duringthe third quarter of 2005, the Company entered into a settlement agreement withthe German tax authorities for $0.5 million and the remaining accrual of $0.3million was reversed and recorded as a reduction of selling, general andadministrative (“SG&A”) expenses.

 

*Lettersof Credit*

GTSIwas obligated under an operating lease to provide its landlord with a letter ofcredit in the amount of $0.2 million at September 30, 2005 and $0.8million at December 31, 2004, as a security deposit for all tenantimprovements associated with the lease.

 

Asof September 30, 2005, GTSI had an outstanding letter of credit to acustomer in the amount of $1.75 million to guarantee the performance by the Companyof all obligations under a specific contract. This obligation is expected to expire in February 2006.

 

*LegalProceedings*

TheCompany is occasionally involved in various lawsuits, claims, andadministrative proceedings, including employee matters, arising in the normalcourse of business. The Company believes that any liability or loss associatedwith such matters, individually or in the aggregate, will not have a materialadverse effect on the Company’s financial condition or results of operations.

 

In the $25 million lawsuitfiled against GTSI previously reported in the Company’s periodic reports filedwith the SEC, the case went to trial in March 2005.  The Courtgranted GTSI’s motion to strike, and in late July entered a final order infavor of GTSI and awarded GTSI $1.4 million in attorneys’ fees and costs. The plaintiff filed an appeal in October 2005.  Managementcontinues to believe the claim is without merit and intends to vigorouslydefend any appeal, but the ultimate outcome of this matter remains uncertain.No amounts have been accrued as of September 30, 2005.

 

**13. Subsequent Events**

 

In October 2005, inorder to reduce operating costs going forward and better align its workforcewith its business operations, the Company took certain actions to improve theCompany’s competitive and strategic position including layoffs, termination ofconsultant agreements, elimination of open positions and other cost savingsmeasures. Through workforce alignment and normal attrition, the Company reducedits workforce to provide a platform for future profitability. Reductions werethroughout the organization, aligning the business with sales and operationalobjectives while minimizing disruptions to the Company’s customers. Managementis focused on building the right organizational structure to profitably run thebusiness.

 

**14. Restatement ofPreviously Issued Financial Statements**

 

InNovember 2005, the Company determined it had inadvertently expensed ratherthan amortized costs related to its employee retention programs in the secondquarter of 2005.  The expense of approximately $1.0 million that wasinitially recorded in the second quarter should have been amortized over the 12-monthfuture service period required for the retention program.  As a result,the Company’s second

 

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quarternet income was understated by approximately $0.6 million as initially stated inits Form 10-Q for the second quarter.

 

TheCompany promptly notified both its Audit Committee and its independentaccountants. Under the direction and oversight of the Audit Committee, theCompany made a prior period adjustment to its unaudited quarterly financialinformation for the period ending June 30, 2005 and will be restating itsfinancial statements, by means of filing an amended Form 10-Q for thesecond quarter of 2005 as soon as reasonably practicable, primarily as a resultof reduced expenses for that period.

 

Allfinancial information for the three and nine months ended September 30,2005 in this Quarterly Report on Form 10-Q is presented inclusive of theresulting revisions of amortizing this expense over twelve months.

 

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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 consolidatedfinancial statements and notes included in this Quarterly Report on Form 10-Qand our consolidated financial statements and notes in our Annual Report on Form 10-Kfor the year ended December 31, 2004, as amended by Forms 10-K/A filed withthe SEC on April 29, 2005 and August 1, 2005 (“2004 Form 10-K”).  We use the terms “GTSI,” “we,” “our,” and“us” to refer to GTSI Corp. and its subsidiaries.

 

**DisclosureRegarding Forward-Looking Statements**

 

Readersare cautioned that this Quarterly Report on Form 10-Q containsforward-looking statements within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended, relating to our operations that are based onour current expectations, estimates, forecasts and projections. Words such as“expect,” “plan,” “believe,” “anticipate,” “intend” and similar expressions are intended to identify theseforward-looking statements.  Thesestatements are not guarantees of future performance and are subject to risks,uncertainties and assumptions that are difficult to predict.  Therefore, actual results in future periodsmay differ materially from those expressed or projected in any forward-lookingstatements because of a number of risks and uncertainties, including:

 

•                  The seasonality of our business makes ourfuture financial results less predictable, which may adversely affect our stockprice;

•                  Fluctuations in our gross margins;

•                  Any issue that compromises our relationshipwith agencies of the federal government would cause serious harm to ourbusiness;

•                  Our ability to recruit, retain and motivatetalented employees;

•                  Our exposure to inventory risks;

•                  Infrastructure failures could have a materialadverse effect on our business;

•                  Our qualifications as a small business fornew and current contract awards;

•                  Our reliance on our vendor relationships andthe availability of products;

•                  Changes in federal government fiscalspending; and

•                  Productivity challenges arising from theimplementation of the supply chain management phase of GTSI’s Enterprise ManagementSystem (“GEMS”).

 

Fora detailed discussion of risk factors affecting GTSI’s business and operations,see Item 1, Business, “Risk Factors” in our 2004 Form 10-K. We undertakeno obligation to revise or update any forward-looking statements for anyreason.

 

**Overview**

 

GTSIis a recognized IT solutions leader, providing products and services primarilyto federal government customers worldwide. One of our key differentiators is the extensive number of contractvehicles we have in our portfolio.  Formore than two decades GTSI has served the public sector by partnering withglobal IT leaders such as Panasonic, HP, Sun Microsystems, Cisco and Microsoftto provide cutting edge technology to the government. Several years ago wecreated a sales division focused on growing our

 

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integratorbusiness and expanding sales of our managed services offerings. Today ourbusiness is moving away from a commodity fulfillment model to one selling morecomplex, higher margin solutions.

 

Ourcorporate headquarters and distribution center are located in Chantilly,Virginia. Another of our differentiators is our ISO 9001:2000 certifieddistribution center which offers many benefits and services, includingintegration services, custom asset tagging, image configuration and loading,custom packaging and staging, recovery disk and degaussing hard drive cleansing.We also offer a number of services at our integration and distribution centerincluding:

 

•                  Project Management of Complex IntegrationPrograms;

•                  Complex System “Builds”;

•                  Global Warehousing;

•                  Staged Deployments;

•                  Program-Specific Catalogs;

•                  Logistics and Transportation Management;

•                  System Installation and De-installation;

•                  Pre-build and Stage any size order; and

•                  Full Compliance with DOD RFID mandate.

 

In the beginning of 2004, we reviewed ourhistorical financial performance in conjunction with a competitive marketanalysis, and concluded that GTSI held only a small market share percentage ina highly fragmented, growing government IT market. GTSI’s management teambelieved we could substantially increase our sales growth by hiring additionalsales people to penetrate areas of the government IT market that had previouslybeen underserved. In July 2004,we announced and embarked upon a strategic plan seeking to double revenue,improve margin, and increase productivity by 2007. During the second half of 2004, we increased the number of employees by20% to approximately 850 employees. During 2005, we continued toselectively hire employees resulting in a peak level of nearly 900 employees.Subsequent to September 30, 2005, in order to better align our workforcewith our business operations, we reduced our head count to approximately 830employees through a combination of layoffs and voluntary attrition.

 

Firstquarter sales were significantly weaker than projected under our 2005 operatingbudget, declining approximately 12% from the same period in 2004. While weadded approximately 150 additional people during the second half of 2004, theseresources were not as productive from a revenue generation perspective aspreviously contemplated. Second quarter sales continued to fall belowprojections and were $78.3 million lower than in the same period of the prioryear due to delays in booking orders and shipping products to our customers asa result of our difficulties in implementing GEMS. Our results for the ninemonths ended September 30, 2005 were nearly 20% lower than the nine monthsended September 30, 2004 and resulted in a net loss of $8.7 million for2005. Management contributes this result to 1) a change in the sales mix tomore complex transactions with longer sales cycles 2) lower employeeproductivity and 3) increased turnover, especially in our sales organization. Managementcontinues to be focused on driving profitable sales and net income growth, but ithas concluded as unlikely that our sales will double by 2007.

 

Asdiscussed in more detail throughout our MD&A for the three and nine monthsended September 30, 2005 compared to September 30, 2004:

•                  Year to date sales decreased $142.9 million,or 19.1%, from the same period last year;

•                  Net loss for the nine months ended September 30,2005 was $8.7 million, due to reduced sales compounded by a 15.5% increase in selling,general and administrative expenses mostly from our additional headcount;

 

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•                  We continue to generate cash flows fromoperations and have no long-term debt on our balance sheet; and

•                  The implementation of the supply chainmanagement module of our enterprise resource planning system required cashoutflows of $3.7 million during the nine months ended September 30, 2005 andnegatively affected our year to date sales and productivity.

 

**GEMS**

 

GEMSwas implemented in April 2005, replacing our legacy system. Managementbelieved that this new information platform was essential to our long-termsuccess. This implementation had a significant impact on our businessoperations, resulting in weak revenue performance in the beginning of the yearwhich negatively affected our year to date financial results. Although our GEMSimplementation caused major disruptions to our customers, we believe the systemcutover difficulties are largely behind us. During the peak buying season ofthe Federal government, GEMS was less of an issue, even when we produced thehighest sales month in the history of GTSI.

 

Asa result of the operational difficulties associated with the transition toGEMS, we temporarily suspended the monthly reporting of revenue, backlog andbookings during the second quarter of 2005. However, we disclosed this datawith our second quarter earnings results. Beginning in July 2005, ourmonthly external reporting resumed.

 

Thesignificant amount of resources focused on GEMS since late 2004 resulted indecreased productivity and significant cash outlays. During the nine monthsended September 30, 2005, we capitalized $1.8 million of costs on ourbalance sheet and incurred an additional $1.9 million of expense for GEMS. In July 2005,we installed three key productivity enhancements as part of the planned 1.1release of GEMS. We are undertaking an analysis related to further upgrades andenhancements to the system to improve productivity throughout GTSI. Managementexpects to continue to invest in GEMS to improve productivity throughout GTSI. Cashoutlays are projected to be an additional $1.5 million of capitalized andexpensed costs during the fourth quarter of 2005.

 

**CriticalAccounting Estimates**

 

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 significant assumptions. Webelieve that some of the more critical estimates and related assumptions thataffect our financial condition and results of operations are in the areas of merchandiseinventories, long-lived assets, warranties, contingencies, and revenuerecognition. For more information on critical accounting estimates, see theMD&A included in Part II, Item 7 of our 2004 Form 10-K.  We have discussed the application of thesecritical accounting estimates with the Audit Committee of our Board ofDirectors.

 

During the three months ended September 30, 2005, we did notchange or adopt any new accounting estimates or policies that had a materialeffect on our consolidated financial condition or results of operations.

 

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**Historical Results of Operations**

 

Thefollowing table illustrates the unaudited percentage of sales represented byitems in our consolidated statements of operations for the periods presented.

 
| ** **                                          | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                          | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                |       |                                       |       |                                      |       |   |   |   |   |
| Sales                                               |       | 100.0                                      | %          | 100.0                                     | %          | 100.0 | % | 100.0 | % |
| Cost of sales                                       |       | 87.8                                       |       | 85.9                                      |       | 88.5 |   | 88.5 |   |
| Gross margin                                        |       | 12.2                                       |       | 14.1                                      |       | 11.5 |   | 11.5 |   |
| Selling, general & administrative expenses |       | 11.1                                       |       | 9.2                                       |       | 14.6 |   | 10.2 |   |
| Income (loss) from operations                       |       | 1.1                                        |       | 4.9                                       |       | (3.1 | ) | 1.3 |   |
| Interest and other income, net                      |       | 1.5                                        |       | 0.3                                       |       | 0.9 |   | 0.4 |   |
| Income (loss) before income taxes                   |       | 2.6                                        |       | 5.2                                       |       | (2.2 | ) | 1.7 |   |
| Income tax provision (benefit)                      |       | 1.0                                        |       | 2.0                                       |       | (0.8 | ) | 0.7 |   |
| Net income (loss)                                   |       | 1.6                                        | %          | 3.2                                       | %          | (1.4 | )% | 1.0 | % |

 

Thefollowing tables illustrate for the periods indicated, the approximate sales byproduct, by contract vehicle and by vendor, along with related percentages oftotal sales.

 
| ** **                           | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|--------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| **Contract  Vehicles**               | ** ** | **2005**                                  | ** ** | **2004**                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                 |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| GSA Schedules                        |       | $                                         | 22.8       |                                     | 7.9        | % | $ | 105.7 |   | 32.0 | % | $ | 62.5 |   | 10.3 | % | $ | 202.7 |   | 27.1 | % |
| IDIQ Contracts                       |       | 138.8                                     |       | 48.2                                     |       | 127.6 |   | 38.6 |   | 259.7 |   | 42.9 |   | 293.6 |   | 39.2 |   |
| Open Market                          |       | 66.3                                      |       | 23.1                                     |       | 72.9 |   | 22.1 |   | 150.5 |   | 24.9 |   | 168.7 |   | 22.5 |   |
| Subcontracts and  Other Contracts    |       | 59.8                                      |       | 20.8                                     |       | 24.4 |   | 7.3 |   | 132.7 |   | 21.9 |   | 83.3 |   | 11.2 |   |
| Total                                |       | $                                         | 287.7      |                                     | 100.0      | % | $ | 330.6 |   | 100.0 | % | $ | 605.4 |   | 100.0 | % | $ | 748.3 |   | 100.0 | % |
|                                 |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| ** **                           | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
| **Top 5  Vendors**                   | ** ** | **2005**                                  | ** ** | **2004**                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                 |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Panasonic                            |       | $                                         | 52.2       |                                     | 18.1       | % | $ | 65.7 |   | 19.9 | % | $ | 125.1 |   | 20.7 | % | $ | 136.2 |   | 18.2 | % |
| Sun Microsystems                     |       | 50.0                                      |       | 17.3                                     |       | 40.3 |   | 12.2 |   | 86.7 |   | 14.3 |   | 98.0 |   | 13.1 |   |
| HP                                   |       | 43.4                                      |       | 15.1                                     |       | 47.7 |   | 14.4 |   | 77.2 |   | 12.7 |   | 97.4 |   | 13.0 |   |
| Cisco                                |       | 27.5                                      |       | 9.6                                      |       | 50.1 |   | 15.2 |   | 67.0 |   | 11.1 |   | 94.0 |   | 12.6 |   |
| Microsoft                            |       | 8.5                                       |       | 3.0                                      |       | 28.9 |   | 8.7 |   | 28.9 |   | 4.8 |   | 44.9 |   | 6.0 |   |
| Other                                |       | 106.1                                     |       | 36.9                                     |       | 97.9 |   | 29.6 |   | 220.5 |   | 36.4 |   | 277.8 |   | 37.1 |   |
| Total                                |       | $                                         | 287.7      |                                     | 100.0      | % | $ | 330.6 |   | 100.0 | % | $ | 605.4 |   | 100.0 | % | $ | 748.3 |   | 100.0 | % |
|                                 |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| ** **                           | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
| **Product**                          | ** ** | **2005**                                  | ** ** | **2004**                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                 |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Hardware                             |       | $                                         | 225.0      |                                     | 78.2       | % | $ | 247.0 |   | 74.7 | % | $ | 468.0 |   | 77.3 | % | $ | 573.7 |   | 76.7 | % |
| Software                             |       | 42.3                                      |       | 14.7                                     |       | 69.0 |   | 20.9 |   | 86.2 |   | 14.2 |   | 115.3 |   | 15.4 |   |
| Resold  third-party service products |       | 15.1                                      |       | 5.3                                      |       | 11.7 |   | 3.5 |   | 37.1 |   | 6.2 |   | 48.5 |   | 6.5 |   |
| Services                             |       | 5.3                                       |       | 1.8                                      |       | 2.9 |   | 0.9 |   | 14.1 |   | 2.3 |   | 10.8 |   | 1.4 |   |
| Total                                |       | $                                         | 287.7      |                                     | 100.0      | % | $ | 330.6 |   | 100.0 | % | $ | 605.4 |   | 100.0 | % | $ | 748.3 |   | 100.0 | % |

 

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**ThreeMonths Ended September 30, 2005 Compared With the Three Months Ended September 30,2004**

 

*Sales*

Salesconsist of revenue from products delivered and services sold or rendered, netof allowances for customer returns and credits. During the three months ended September 30,2005 our revenue was weaker than projected, due to decreased productivity fromthe related factors of increased turnover in our sales organization anddifficulties associated with the implementation of GEMS.

 

Althoughsales for the three months ended September 30, 2005 of $287.7 million weredown $42.9 million, or 13.0%, from $330.6 million in the same period in 2004,sales for the month of September 2005 increased $7.8 million over September 2004.Management believes the strong finish in September indicates mostGEMS-related implementation difficulties have been overcome. Our decrease insales during the third quarter was principally due to the $82.9 million declinein revenue under our GSA Schedule contract. Sales under our GSA Schedule declinedfrom nearly one-third of our business during the third quarter of 2004 to lessthan ten percent during the same period in 2005. This decrease was related tothe Department of Defense mandate to use DoD contract vehicles, and GSA Schedulesonly on a waiver basis. Our decline in GSA Schedule sales was offset bythe $35.4 million increase in Subcontracts and Other Contracts which more thandoubled the percentage of our business in this category from third quarter 2004sales. This increase is related to our focus on growing our integrator businessand moving away from a commodity fulfillment model to selling more complex,higher margin solutions. This focus is also responsible for the $2.4 millionincrease during 2005 in consulting and other services sales to $5.3 million asof September 30, 2005. We expect our service revenue to continue toincrease as a percentage of our sales. As shown in the sales by product tableon the preceding page, our sales from hardware and software products aredeclining, while resold third-party service products and services revenues areincreasing.

 

Duringthe last three years we have focused on building stronger partnerships with ourkey vendors and migrating our focus and value proposition to enterprise-levelapplications and solutions. We now have a set of key applications and solutionsthat have become the focal point of the majority of our business. In each ofthese strategically evolved solutions, we have considered customer requirementsand partner attributes to achieve the most intelligent combinations of projectsand services. Management plans to place more emphasis on delivering thesefocused applications and solutions to our government customers to scale GTSIwhile driving productivity. Sales of products from our top five vendors duringthe three months ended September 30, 2005 and 2004 accounted for approximately63% and 70%, respectively.  Our sales ofSun Microsystems products increased nearly 25% during the quarter to $50.0million. Sales of Cisco products declined almost 50% from third quarter 2004related to changes in Cisco’s marketing strategy towards more direct sales.

 

*Backlog*

Werecognize an order as backlog when we receive and accept a written customerpurchase order.  Our total backlogincludes orders that have not shipped (“unshipped backlog”) as well as ordersthat have shipped but cannot be recognized as sales at the period end. Totalbacklog increased $39.3 million, or 15.3%, from $257.0 million at September 30,2004 to $296.3 million at September 30, 2005. The majority of thisincrease was due to the increase in unshipped backlog to $276.0 million at September 30,2005, compared to $239.6 million at September 30, 2004. Backlog fluctuatessignificantly from period to period due to the seasonality of governmentordering patterns and fluctuations in inventory availability of variousproducts.

 

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*GrossMargin*

Grossmargin is Sales less Cost of sales, which includes product cost, freight,warranty maintenance costs and certain other expenses related to the cost ofacquiring products. Gross margin dollars declined $11.6 million, or 24.8%, forthe three months ended September 30, 2005 to $35.0 million as compared tothe same period of the prior year. Our gross margin is impacted by theattainment of vendor incentive funds which are recorded as a reduction of Costof sales. Vendor incentives for the third quarter 2005 declined $2.8 millionfrom the third quarter of 2004 to the third quarter of 2005. This decline was dueto a change in one vendor incentive program from monthly in 2004 to quarterlyin 2005, and changes in other vendor programs coupled with lower productshipments during the quarter ended September 30, 2005.  Sales during the month of September comprised$21.6 million of our gross margin dollars for the quarter. Nearly 50% of thisgross margin was generated from our top four largest deals as a result of ourbusiness model moving toward larger, more complex deals.

 

Grossmargin as a percentage of sales declined to 12.2% in the third quarter of 2005from 14.1% in the third quarter of 2004. The $10.1 million reduction in cost ofsales resulting from the non-cash extinguishment of aged accounts payable accountedfor 3.0% of our 14.1% gross margin at September 30, 2004.  This reduction was offset by a 1.1%improvement in gross margin as a percentage of sales in 2005 due to improvingour pricing strategy and processes, selling more complex solutions to ourcustomers and driving lower costs from our vendors. Gross margin percentagesvary over time and may change significantly depending on our customers’ use ofavailable contract vehicles and the mix of products sold. We expect to continueto increase our gross margin as a percentage of sales by revamping ourpurchasing processes, improving our pricing processes and improving our mix.

 

*Selling,General & Administrative Expenses*

Wehave invested heavily in the business in terms of head count and technology tobuild a larger, more robust organization to capitalize on the marketopportunity we anticipate from the expanding federal government IT budget. Selling,general & administrative (“SG&A”) expenses for the three monthsended September 30, 2005 increased $1.5 million, or 4.9%, from the sameperiod in 2004. Expressed as a percentage of total sales, SG&A expenses increasedfrom 9.2% during the three months ended September 30, 2004 to 11.1% duringthe three months ended September 30, 2005 due primarily to the decline inoverall sales.

 

Inresponse to our sales focus and lower than projected year to date sales, webegan implementing cost savings measures in September 2005. In October 2005,in order to reduce SG&A costs going forward and to improve our competitiveand strategic position, management took certain actions including workforcealignment, termination of consultant agreements and elimination of openpositions. Through a combination of layoffs and normal attrition we reduced ourworkforce to provide a platform for future profitability. We expect theseactions to result in a meaningful reduction of SG&A expenses beginning inthe first quarter of 2006 since certain severance payments during the fourthquarter of 2005 will temper the projected expense decline.

 

*Interestand Other Income, Net*

Interestand other income, net of interest and other expense, increased $3.3 million to$4.3 million during the three months ended September 30, 2005 compared tothe same period in 2004. This increase was principally due to an increase oflease interest income of $4.0 million primarily from the sale of two large leasereceivables in September 2005. Management anticipates increasing participationin leasing activity from our customers. Since we generally sell the resulting leasereceivables, we expect our lease interest income to increase over the next fewyears. This increase was offset by a $0.2 million decline in purchase discountsand an increase of $0.4 million in interest expense on increased borrowings andline of credit fees on our Credit Facility.

 

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*IncomeTaxes*

Ourincome tax provision declined from $6.8 million for the three months ended September 30,2004 to $2.8 million for the three months ended September 30, 2005. Thiswas slightly affected by the decrease in our estimated annual effective taxrate from 39.5% for the three months ended September 30, 2004 to 37.8% forthe same period in our current year. The decline in our effective tax rate forthe three months ended September 30, 2005 was primarily due to our year todate net loss of 8.7 million and the affect of certain permanent taxdifferences. While we estimate our annual income tax rate to be 35.5%, theeffective tax rate on our third quarter earnings was 37.8%. In order to offsetthe income tax benefit accrued on our loss before income taxes of $20.9 millionduring the first half of 2005, income tax expense on our third quarter 2005income before income taxes was calculated at 37.8% to equal an overall annualeffective tax rate of 35.5% for 2005.

 

# **NineMonths Ended September 30, 2005 Compared With the Nine Months Ended September 30,2004**

 

*Sales*

Salesfor the first nine months of 2005 was weaker than projected, declining 19.1% to$605.4 million, compared to $748.3 million in the first nine months of 2004, areduction of $142.9 million.  The $21.6million decrease in first quarter sales was related to lower backlog at thebeginning of the year and lower than expected bookings. Sales declined anadditional $78.3 million during the second quarter caused by problemsassociated with the implementation of GEMS, changing sales mix, and decreasedproductivity due in part to increased turnover in our sales organization. Althoughsales for the third quarter of 2005 declined $42.9 million continuing the 2005trend of lower revenues, sales for the month of September 2005 increased$7.8 million over September 2004. GTSI’s strong finish in September resultedin producing the highest sales month in our history. During 2005, we have noteddeclining trends in sales to our Air Force and Navy customers, as well asdecreased extended warranty sales.  Thistrend has been partially offset by increased sales from certain non-militaryagencies of the Federal government.

 

Ourdecrease in sales during the nine months ended September 30, 2005 wasprimarily due to the $140.2 million decline in revenue under our GSA Schedule contract.Sales under our GSA Schedule declined from more than one-quarter of ourbusiness in 2004 to approximately ten percent during 2005. This decrease wasrelated to vacancies and turnover within our sales force, as well as internalissues at the GSA Agency. The decline in our IDIQ Contracts and Open Marketsales were mostly offset by the $49.4 million, or 59.3% increase inSubcontracts and Other Contracts due to our focus on growing our integratorbusiness and moving toward selling more complex, higher margin solutions. As apercentage of our sales, revenue from Subcontracts nearly doubled to 21.9% ofour 2005 year-to-date sales.

 

Thisfocus is also responsible for the $3.3 million increase during 2005 inconsulting and other services sales to $14.1 million as of September 30,2005. We expect sales from services to continue to increase as a percentage ofsales. All product lines other than services declined from the nine monthsended 2004 to the same period in the current year.

 

Duringthe last three years we have focused on building stronger partnerships with ourkey vendors and migrating our focus and value proposition to enterprise-levelapplications and solutions. Management plans to place more emphasis ondelivering these focused applications and solutions to our government customersto scale GTSI while driving productivity. Sales of products from our top fivevendors during the nine months ended September 30, 2005 and September 30,2004 accounted for approximately 63% of our respective year-to-date sales.While sales to each of our top five vendors decreased from the nine monthsended 2004 to 2005, sales of Cisco and HP declined $27.0 million and $20.2million, respectively, accounting for one-third of the $142.9 million decreasein our sales.

 

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*GrossMargin*

Grossmargin as a percentage of sales remained flat at 11.5% for the nine monthsended September 30, 2004 and 2005. During the nine months ended September 30,2005, 1.3% of our 11.5% gross margin was due to more discipline in our pricingstrategy and processes, selling more complex solutions to our customers and drivinglower costs from our vendors.Whereas, 1.3% of gross margin as a percentage ofsales for the same period in 2004 was due to the non-operating $10.1 millionextinguishment of aged accounts payable. Gross margin dollars decreased $16.5million, or 19.2%, from the nine months ended September 30, 2004 to $69.8million for the nine months ended September 30, 2005. This decrease was dueto lower total sales and a corresponding decline in vendor incentives of $3.3million which are recorded as a reduction of Cost of sales.

 

*SG&AExpenses*

SG&Aexpenses for the nine months ended September 30, 2005 increased $11.9million, or 15.5%, from the same period in 2004.  This increase was primarily due to increased salaryexpenses of $9.2 million and a $2.5 million increase in employee benefit costs fromincreased headcount. During the nine months ended September 30, 2005,SG&A expenses included $1.9 million of GEMS related expenses for consulting,training and depreciation. SG&A expenses as a percentage of sales increased4.4 percentage points to 14.6% for the nine months ended September 30, 2005.

 

Inresponse to our sales focus and lower than projected year to date sales, webegan implementing cost savings measures in September 2005. In October 2005,in order to reduce SG&A costs going forward and to improve our competitiveand strategic position, management took certain actions including workforcealignment, termination of consultant agreements and elimination of openpositions. Through a combination of layoffs and normal attrition, we reducedour workforce to provide a platform for future profitability. We expect theseactions to result in a meaningful reduction of SG&A expenses beginning inthe first quarter of 2006 since certain severance payments during the fourthquarter of 2005 will temper the projected expense decline.

 

*Interestand Other Income, Net*

Interestand other income, net during the nine months ended September 30, 2005 totaled$5.4 million, an increase of $2.6 million over the same period in 2004. This increasewas due to additional lease interest income of $3.6 million primarily due tothe sale of two large lease receivables during September of 2005, offsetby a $0.4 million decline in purchase discounts, $0.2 million loss on an equityinvestment and an increase of $0.4 million in interest and fees on our creditfacility.

 

*IncomeTaxes*

Werecorded a tax benefit of $4.8 million for the nine months ended September 30,2005 compared to a tax provision of $4.9 million in the same period lastyear.  This change was due to GTSI’s lossbefore income taxes of $13.4 million for the nine months ended September 30,2005. Our income tax benefit for 2005 was calculated at an estimated annualeffective tax rate of 35.5%, compared to 39.5% estimated income tax rate at September 30,2004. The decrease in the effective tax rate is due primarily to the impact of ourprojected permanent differences between book and tax income on the projected netloss for the fiscal year ending December 31, 2005.

 

**SeasonalFluctuations**

 

In recent years, approximately95% of our annual sales have been earned from departments and agencies of theU.S. Federal Government, either directly or indirectly through systemintegrators to which GTSI is a sub-contractor. Management has noted a trend inour sales to prime contractors increasing as a

 

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percentage of our totalsales. We believe this trend is caused by the buying patterns of our customers and GTSI’s shift tolarger, more complex orders. We have historically experienced, and expect tocontinue to experience, significant seasonal fluctuations in our operations asa result of government buying and funding patterns, which also affect thebuying patterns of GTSI’s prime contractor customers.  These buying and funding patternshistorically have had a significant positive effect on our bookings in thethird quarter ended September 30 each year (the federal government’s fiscalyear end), and consequently on sales and net income in the third and fourthquarters of each year.

 

Historically, sales during the first nine months ofour fiscal year have comprised approximately 69% of our total annual sales. Dueto the increased trend towards larger purchases by our customers (which resultsin longer preparation and delivery times) and the order fulfillment challengesand shipping delays caused by GEMS during the second quarter of 2005, managementbelieves our year-to-date performance will represent a smaller proportion ofour annual sales than historic trends. However, the seasonality of ourbusiness, and the unpredictability of the factors affecting such seasonality,makes GTSI’s quarterly and annual financial results difficult to predict andsubject to significant fluctuation. Our quarterly financial results are alsoaffected by the timing of contract awards, the receipt of products by thecustomer, and the incremental turnover costs to replace employees.

 

**Liquidity and Capital Resources**

 

*Cash flows for the nine months ended September 30,*(in millions)

 
| ** **                            | ** ** | **2005** | ** ** | **2004** | ** ** | **(Decrease)  Increase** | ** ** |
|---------------------------------------|------------|----------|------------|----------|------------|--------------------------|------------|
| Cash provided by operating activities |       | $        | 4.6        |     | $          | 17.0                     |       | $ | (12.4 | ) |
| Cash used in investing activities     |       | $        | (3.1       | )        | $          | (5.7                     | )          | $ | (2.6 | ) |
| Cash used in financing activities     |       | $        | (1.9       | )        | $          | (11.3                    | )          | $ | (9.4 | ) |
|                                       |            |          |            |          |            |                          |            |  |  |  |  |

 

Duringthe nine months ended September 30, 2005, we continued to generatepositive cash flow from operations, although $12.4 million less than the sameperiod last year.  This decrease was primarilydue to our $8.7 million year to date net loss in 2005, compared to net incomeof $7.5 million for the nine months ended September 30, 2004. This netdifference of 16.2 million was offset by net changes in assets and liabilitiesof $3.0 million and $0.8 million in increased amortization from theimplementation of GEMS. In the absence of substantial cost reductions necessaryto return us to profitability, there is no assurance that we will be able tomaintain positive cash flow from operations in future periods.

 

Cashused in investing activities decreased $2.6 million from the nine month periodended September 30, 2004 to 2005 due to a decline in our investment inGEMS from $4.3 million during the first nine months of 2004 to $1.8 millionduring the same period of the current year.

 

Cashused in financing activities declined $9.4 million from the nine months ended September 30,2004 to 2005 primarily due to $11.6 million more net payments of notes payablein 2004. This decline was offset by $3.0 million of cash used to purchasetreasury stock under our share repurchase plan during the nine months ended September 30,2005. We did not purchase any treasury stock during 2004. In addition, proceedsfrom exercises of common stock options increased $1.0 million during the nine monthsended September 30, 2005 from $1.1 million during the nine months ended September 30,2004, mainly due to the exercise of 400,000 stock options by our ChiefExecutive Officer during the second quarter of 2005. Cash received during the ninemonths ended September 30, 2005 from the employee stock purchase plan declined$0.2 million from the nine months ended September 30, 2004 due to lessemployee participation.

 

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*Liquidity*

AtSeptember 30, 2005, we have no long-term debt. Our working capital decreased$12.8 million from $79.0 million at December 31, 2004. As of September 30,2005, our working capital was $66.3 million, as compared to $72.5 million and$56.8 million for the same periods in 2004 and 2003, respectively. GTSI’scurrent assets are $44.6 million more as of September 30, 2005 than at theend of our fiscal year. This increase is related to an increase in merchandiseinventories of $21.1 million predominantly due to inventory in transit to customerswhich was shipped FOB destination during the last week of September 2005. Ofour $80.3 million total inventory, $22.6 million of inventory is not reserved forcustomer orders. Accounts receivable increased $10.8 million period over periodrelated to the $7.8 million increase in sales during the month of September comparedto September 2004. Lease receivables were $4.7 million higher at September 30,2005, primarily as a result of large leasing deals with two customers duringSeptember. Finally, the increase in other current assets was related to a $5.6million increase in income taxes receivable expected as a result of ourprojected 2005 net loss and a $1.7 million increase in prepaids. At September 30,2005 our current ratio was equal to the industry average of 1.3.

 

InApril 2005, at its regularly scheduled quarterly meeting, GTSI’s Board ofDirectors approved an increase to GTSI’s share repurchase program. Theincreased authorization was for $7.3 million which, combined with the remaining$2.7 million available under previous authorizations, resulted in $10.0 millionavailable for purchases of treasury stock. Our treasury stock is generallyreissued upon exercise of employee stock options and for the employee stockpurchase plan. We purchased 213 thousand shares of common stock during thethree months ended September 30, 2005 at a cost of $1.7 million. Duringthe nine months ended September 30, 2005, we purchased 374 thousand sharesof common stock for a total of $3.0 million. As of September 30, 2005, wehad remaining authorization to purchase $7.0 million of GTSI’s common stock.However, under the terms of our Credit Facility, purchases of GTSI common stockduring the fourth quarter are restricted to $1.9 million.

 

*Bank CreditFacility*

AtSeptember 30, 2005, GTSI had a $135 million revolving line of credit witha group of lenders (the “Credit Facility”). During 2005, three amendments tothe Credit Facility were executed predominantly to change the amount of theCredit Facility, add lenders to the lender syndicate, obtain waivers of certaincovenant defaults and modify the covenants applicable for the remainder of2005. The Credit Facility includes a revolving line of credit (the “Revolver”)and a provision for inventory financing of vendor products. The CreditFacility, unless terminated earlier, will continue after the maturity date of February 28,2006 unless any party gives the other party written notice of termination notless than 90 days prior to the start of a new renewal period.

 

Borrowing under the Revolveris limited to 85% of eligible accounts receivable. Borrowing under the CreditFacility is secured by substantially all of our assets. The Revolver carries aninterest rate indexed to the London Interbank Offered Rate (“LIBOR”) plus 1.75percentage points. The Credit Facility also contains certain covenants as wellas provisions specifying compliance with certain monthly and annual financialratios. At September 30, 2005, we were in compliance with all financialcovenants set forth in the Credit Facility and had available credit of $8.3 millionat September 30, 2005 and $59.1 million at December 31, 2004.

 

*CapitalResources and Requirements*

Ourongoing capital requirements depend on a variety of factors, including theextent to which we are able to fund the cash needs of our business fromoperations. As of September 30, 2005 GTSI was obligated under two lettersof credit totaling $1.9 million. Our contractual obligations under ouroperating leases as of September 30, 2005 are consistent with our year-enddisclosure in Item 7, MD&A “Contractual Obligations” of our 2004 Form 10-K.We have no commitments to purchase inventory, property or equipment. During thenine months ended September 30, 2005 we made capital expenditures

 

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of$3.1 million, primarily $1.8 million for the implementation of GEMS and $0.7million for computers and peripherals. We anticipate capital expenditures of anadditional $0.7 million for GEMS during 2005 as we continue to developenhancements to our system.

 

Eventhough GTSI experienced a significant net loss of $13.3 million in the firsthalf of the year, we were able to recoup some of those losses with a successfulthird quarter. Despite the fact that GTSI’s net loss for the nine months ended September 30,2005 was $8.7 million, we were able to maintain positive cash flows fromoperations. Management expects our cash flows from operations to increase forthe year ending December 31, 2005 due to the seasonal nature of our business.However, there is no assurance we will be able to maintain positive cash flowfrom operations in the future if sales during the fourth quarter fall belowprojections or if our actions to reduce operating costs are insufficient inreturning GTSI to profitability. We anticipate that we will continue to relyprimarily on operating cash flow, vendor credit and our Credit Facility tofinance our operating cash needs. We believe that such funds should besufficient to satisfy our near term anticipated cash requirements foroperations.

 

However,if we are not able to generate positive cash flow in the remainder of the yearand we are unable to meet the debt covenants in future periods or obtain awaiver of any such default from our lenders; our Credit Facility may be reducedor restricted. We may seek additional sources of capital, including obtainingpermanent financing over a longer term at fixed rate to finance our workingcapital requirements. GTSI believes that such capital sources will be availableto us on acceptable terms, if needed due to our historical experience and therelationship we have maintained with our lenders.

 

**NewAccounting Pronouncements**

 

InDecember 2004, the Financial Accounting Standards Board (“FASB”) issuedStatement of Financial Accounting Standards (“SFAS”) No. 123 (Revised2004) “Share-Based Payment” (“FAS 123R”), which is a revision of FASB StatementNo. 123 “Accounting for Stock-Based Compensation” (“FAS 123”).  FAS 123R supersedes Accounting PrincipalBoard (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”(“APB 25”) and its related Interpretations. Generally, the approach toaccounting in FAS 123R requires all share-based payments to employees,including grants of employee stock options, to be recognized in the statements ofoperations based on the grant-date fair value of the award.

 

Aspermitted by FAS 123, GTSI currently accounts for share-based payments toemployees using the intrinsic value provisions of APB 25 and, as such,generally recognizes no compensation costs for employee stock options.Accordingly, the adoption of FAS 123R’s fair value method may have asignificant impact on our results of operations.  The impact of the adoption of FAS 123R cannotbe predicted at this time because it will depend on levels of share-basedpayments granted in the future. However, had we adopted FAS 123R in priorperiods, the impact would have approximated the impact of FAS 123 as describedin the disclosure of pro forma net income and earnings per share in Note 3 toour consolidated financial statements in Part I, Item 1 of this Form 10-Q.FAS 123R also requires the benefits of tax deductions in excess of recognizedcompensation cost to be reported as a financing cash flow, rather than as anoperating cash flow, as required under current literature. This requirementwill reduce cash flows from operating activities and increase cash flows fromfinancing activities in periods after adoption.

 

InApril 2005, the SEC adopted a new rule that amends the compliancedate for FAS 123R to be effective as of the beginning of the first annualreporting period that begins after June 15, 2005. Thus, we plan to adoptthe standard beginning January 1, 2006. FAS 123R offers severalalternatives for implementation.  At thistime, management plans to use the modified prospective transition method. Weare also evaluating the impact of FAS 123R to our employee stock purchase plan.

 

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InJune 2005, the FASB issued SFAS No. 154 “Accounting Changes and ErrorCorrections,” (“FAS 154”) which is a replacement of APB Opinion No. 20“Accounting Changes” and FASB Statement No. 3 “Reporting AccountingChanges in Interim Financial Statements.” FAS 154 changes the accounting forand reporting of changes in accounting principles and error corrections byrequiring retrospective application to prior period financial statements unlessimpracticable. This statement is effective in fiscal years beginning after December 15,2005 and we plan to adopt FAS 154 on January 1, 2006. We do not expect theadoption of FAS 154 to have a significant impact on our financial statements.

 

**Outlook**

 

Duringthe past three fiscal years, sales for the nine months ended September 30 haveaveraged approximately 69% of GTSI’s annual sales. Management expects thispercent to decline during the current year largely because our results in thefirst part of the year were adversely affected by the problems associated withour GEMS implementation during the second quarter of 2005.

 

Weexperienced difficulties during the first part of 2005 in our efforts to match 2004monthly sales figures. However, in September 2005, our monthly salessurpassed September 2004 sales by $7.8 million. In addition to furtherrevenue growth, we believe we have the ability to continue the improvement inour gross margin percentages through more discipline in our pricing strategyand processes, selling more complex solutions to our customers and drivinglower costs from our vendors. Webelieve our business is moving away from a lower-end low margin commodityfulfillment model to one selling higher-end technology and services-basedsolutions. We plan to focus on achieving a higher degree of productivityin the fourth quarter of 2005. Management identified three key initiatives torealize this goal: 1) focusing on increasingly complex solutions andapplications, 2) refining our sales strategy to align our sales teams with ourcustomers and product offerings and 3) achieving operational excellence in ourexecution after the sale.

 

GTSIhas invested resources and focus in a number of areas, including our expansioninto state and local government sales, our investments in our integratorsolutions group, the quality of our people, and the creation of GTSI Financial Services,all of which provide our customers with differentiators versus our competition.We believe our leasing business allows our government customers a way toleverage their present dollars into greater buying power, creating an efficientavenue for securing solutions and delivering mission critical services.

 

Althoughour GEMS implementation during the second quarter of 2005 caused disruptions toour business and a negative impact on our year to date results, we expect ourinfrastructure investment in GEMS to provide the foundation and resourcesnecessary to support a more efficient selling process and improved shipment ofproducts to our customers. In addition, we anticipate the functionality ofGEMS, once mastered, will reduce the lag time between order placement andshipment. Management expects to continue to invest in GEMS in 2006 and isperforming analyses related to further upgrades and enhancements to the system.

 

Managementinitiated a pilot program for a new customer relationship platform (“CRM”)during June 2005. Depending upon the results of the pilot program andmanagement’s evaluation of our existing CRM platform, we may incur animpairment charge for the write-off of our existing CRM software. As of September 30,2005, we have capitalized $0.8 million in costs related to the CRM solution. Utilization of a robust CRM platform isexpected to allow us to become more productive and increase sales of products,services and solutions.

 

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We currently intend to continue to purchase GTSI’scommon stock under the share repurchase program approved by our Board ofDirectors. As of September 30, 2005 we had authorization for additional repurchases of$7.0 million. Under the terms of our Credit Facility, payments for sharesrepurchased during the remainder of 2005 will not exceed $1.9 million.

 

Ouryear to date net loss as of September 30, 2005 was $8.7 million. Wecontinue to see the government market opportunity as robust, and one that isgrowing faster than inflation. Based on this expectation, as well as theseasonality of our business, we anticipate improved results in the fourthquarter of 2005; however, we are projecting an annual net loss for 2005.

 

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

 

Forinformation required by this item see Item 7A “Quantitative and QualitativeDisclosures about Market Risk” of GTSI’s 2004 Form 10-K. Our exposures to marketrisk have not changed materially since December 31, 2004.

 

**ITEM 4.****                                                               ****CONTROLSAND PROCEDURES**

 

Asof the end of the period covered by this report, management performed anevaluation, with the participation of GTSI’s Chief Executive Officer and ChiefFinancial Officer, of the effectiveness of the disclosure controls andprocedures (as defined in Rules13a-15(e) or 15d – 15(e) under theSecurities Exchange Act of 1934, as amended). Based on this evaluation, ourChief Executive Officer and Chief Financial Officer have concluded that ourdisclosure controls and procedures are effective in ensuring that informationrequired to be disclosed by us in reports filed or submitted under theSecurities Exchange Act of 1934, as amended, (i) is recorded, processed,summarized and reported within the time periods specified in the Securities andExchange Commission’s rules and forms and (ii) is accumulated andcommunicated to GTSI’s management including our principal executive officer andour principal financial officer, as appropriate to allow timely decisionsregarding required disclosure.

 

Therewas no change in our internal control over financial reporting during our thirdquarter of fiscal 2005 that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting. In closingthe third quarter of 2005, the Company became aware of issues with itsdocumentation and procedures regarding retention bonuses. Accordingly, we areimplementing improvements that we expect will be effective prior to December 31,2005. The Company believes that its quarterly financial statements presentedherein are fairly stated.

 

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**PART II.  OTHER INFORMATION**

 

# **ITEM1.  LEGALPROCEEDINGS**

 

In the Ichiban lawsuit filed against GTSI in November 2003, theVirginia Circuit Court in March 2005 dismissed the plaintiff’s suitagainst GTSI. In late July the Court entered a final order in favor ofGTSI and awarded GTSI $1.4 million in attorneys’ fees and costs. In October 2005,Ichiban filed an appeal to the Court’s ruling. Management continues to believethe claims are without merit and intends to vigorously defend any appeal, butthe ultimate outcome of this matter is uncertain.

 

**ITEM 2. UNREGISTERED SALES OF EQUITYSECURITIES, USE OF PROCEEDS, AND ISSUER PURCHASES OF EQUITY SECURITIES**

 
| **Period**                                         | ** ** | **Total  Number of  Shares  Purchased** | ** ** | **Average  Price  Paid per  Share** | ** ** | **Total Number  of Shares  Purchased as  Part of Publicly  Announced  Program** | ** ** | **Approximate  Dollar Value  of Shares that  May Yet Be  Purchased  Under the  Program** | ** ** |
|----------------------------------------------------|------------|-----------------------------------------|------------|-------------------------------------|------------|--------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|
| July 1 to July 31, 2005                  |       | 119,300                                 |       | $                                   | 8.18       |                                                                                 | 119,300    |                                                                                          |       |   |
| August 1 to August 31, 2005              |       | 30,700                                  |       | $                                   | 7.23       |                                                                                 | 30,700     |                                                                                          |       |   |
| September 1 to September 30, 2005        |       | 63,300                                  |       | $                                   | 7.25       |                                                                                 | 63,300     |                                                                                          |       |   |
| Total - Three Months Ended September 30, 2005 |       | 213,300                                 |       | $                                   | 7.77       |                                                                                 | 213,300    |                                                                                          | $          | 7,010,068 |   |
|                                                    |            |                                         |            |                                     |            |                                                                                      |            |                                                                                               |            |  |  |

 

GTSI’s common stockrepurchase program was announced in February 2000. GTSI’s Board ofDirectors authorized GTSI to repurchase its common stock for an aggregatepurchase price up to $5.25 million. In January 2002, the Board ofDirectors authorized the use of up to an additional $5.0 million for thepurchase of outstanding shares of the Company’s common stock, provided the pershare price did not exceed the market price. In April 2005, GTSI’s Boardof Directors increased the stock repurchase program by $7.3 million. Thisrepurchase program, as increased, is the only stock repurchase programcurrently in effect and there have been no repurchase programs that haveexpired during the period covered by this report.

 

GTSI’s Credit Facilitydiscussed under Part I, Item I, Note 3 to the condensed consolidatedfinancial statements of this Form 10-Q includes restrictions on GTSI’sworking capital as well as limitations uponthe payment of dividends and the purchase of GTSI’s stock.  The CreditFacility prohibits the Company from paying cash dividends on its stock duringthe period from August 8, 2005 through December 31, 2005.  TheCompany has never paid any cash dividends and does not anticipate paying cashdividends on its common stock in the foreseeable future.  The Credit Facility permits the Companyduring this same period to purchase its stock only if the following conditionsare satisfied:  (a) the purchase prices for the stock do not exceedin the aggregate $2.5 million, (b)  no default exists under the CreditFacility and no default or event of default will occur or is reasonably likelyto occur as a result of any such purchase, (c) there is at least $7.5million of Excess Eligible Accounts under the Credit Facility after givingeffect to the contemplated purchase, and (d) an additional reserve istaken against GTSI’s borrowing base under the Credit Facility equal to theaggregate purchase price paid for the stock. As of September 30, 2005, theCompany’s purchase of its stock is restricted to $1.9 million.

 

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TheCredit Facility, as amended, provides that if, after December 31, 2005,there is no existing default and no default or event of default is reasonablylikely to occur as a result of such payment, the Company may annually makepayments aggregating up to $2.5 million for stock purchases, cash dividends andcertain prepayments of debt. Additionally, if there is (a) noexisting default and no default or event of default will occur or is reasonablylikely to occur as a result of such payment and (b) at least $7.5 millionof Excess Eligible Accounts under the Credit Facility, after giving effect tothe contemplated purchase, the Company may make payments of any amount forstock purchases.

 

**ITEM 6.  EXHIBITS**

 

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

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on November 14, 2005 on its behalf bythe undersigned thereunto duly authorized.

 
| ** ** | **GTSI  Corp.**                                    |
|------------|----------------------------------------------------|
|       |                                               |
|       | /s/  M. DENDY YOUNG                                |   |
|       | M.  Dendy Young                                    |
|       | Chairman  and Chief Executive Officer              |
|       |                                               |
|       | /s/  THOMAS A. MUTRYN                              |   |
|       | Thomas  A. Mutryn                                  |
|       | Senior  Vice President and Chief Financial Officer |

 

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**EXHIBIT INDEX**

 

 
| **Exhibit** | ** ** | ** **                                                                                                                                                     |
|-------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number**  | ** ** | **Description**                                                                                                                                                |
| 10.1        |       | Form of  Letter of Agreement signed by Scott W. Friedlander, Thomas A. Mutryn and Scot  Edwards regarding second quarter bonus payments* (filed herewith) |
| 31.1        |       | Section 302  Certification of Chief Executive Officer (filed herewith)                                                                                    |
| 31.2        |       | Section 302  Certification of Chief Financial Officer (filed herewith)                                                                                    |
| 32          |       | Section 906  Certification of Chief Executive Officer and Chief Financial Officer (filed  herewith)                                                       |

 

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*Management compensatory arrangements required to befiled pursuant to Item 15 (c).

 

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