**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

**FORM 10-Q**

** **

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

 

**For the quarterly period ended March 31, 2006**

** **

**Commission File Number:     0-19394**

 

**GTSI Corp.**

(Exact name of registrant as specified in its charter)

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

** **

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

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days. YES x   NO o

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

Large accelerated filer o      Acceleratedfiler x   Non-accelerated filer o

The number of shares of common stock, $0.005 par value, outstanding asof April 30, 2006 was 9,380,842.

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

 

----

**GTSI CORP.Form 10-Q for the Quarter Ended March 31, 2006**

**INDEX**
|                                               | ** ** | ** **                                                                                                            |   | **Page** |
|-----------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------|--------|----------|
| **PART I  — FINANCIAL INFORMATION** |       |                                                                                                                  |
| ** **                                    | ** ** | ** **                                                                                                            |   |     |
| ITEM  1.                                      | ** ** | FINANCIAL  STATEMENTS—                                                                                           |   |     |
| ** **                                    | ** ** |                                                                                                                  |   |     |
| ** **                                    | ** ** | Condensed Consolidated Balance Sheets as of  March 31, 2006 (Unaudited) and December 31, 2005               |   |     |
| ** **                                    | ** ** |                                                                                                                  |   |     |
| ** **                                    | ** ** | Condensed Consolidated Statements of Operations for  the Three Months  Ended March 31, 2006 and 2005 (Unaudited) |   |     |
| ** **                                    | ** ** |                                                                                                                  |   |     |
| ** **                                    | ** ** | Condensed Consolidated Statements of Cash Flows for  the  Three Months Ended March 31, 2006 and 2005 (Unaudited) |   |     |
| ** **                                    | ** ** |                                                                                                                  |   |     |
| ** **                                    | ** ** | Notes to Condensed Consolidated Financial Statements  (Unaudited)                                                     |   |     |
|                                          | ** ** |                                                                                                                  |   |     |
| ITEM 2.                                  | ** ** | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCondition and Results of Operations                             |   |     |
|                                          | ** ** |                                                                                                                  |   |     |
| Item 3.                                       | ** ** | Quantitative And Qualitative Disclosures About Market  Risk                                                           |   |     |
|                                          | ** ** |                                                                                                                  |   |     |
| Item  4.                                      | ** ** | Controls  and Procedures                                                                                              |   |     |
| ** **                                    |       | ** **                                                                                                            |   |     |
| **PART II  — OTHER INFORMATION**    |       |                                                                                                                  |
| ** **                                    |       | ** **                                                                                                            |   |     |
| Item 3.                                       | ** ** | Defaults upon Senior Securities                                                                                       |   |     |
|                                          | ** ** |                                                                                                                  |   |     |
| Item 6.                                       | ** ** | Exhibits                                                                                                              |   |     |
|                                          | ** ** |                                                                                                                  |   |     |
| **SIGNATURES**                                |       |                                                                                                                  |
| ** **                                    |       | ** **                                                                                                            |   |     |
| **EXHIBIT INDEX**                             |       |                                                                                                                  |

 

1

----

**PART I.FINANCIAL INFORMATION**

###### **ITEM1.  FINANCIAL STATEMENTS**

**GTSI CORP.CONDENSED CONSOLIDATED BALANCE SHEETS**(In thousands, exceptshare and per share data)
| ** **                                                                                                                                                                                                             | ** ** | **(Unaudited)**    | ** ** | ** **            | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                             | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
| ** **                                                                                                                                                                                                             | ** ** | **2006**           | ** ** | **2005**              | ** ** |
| **ASSETS**                                                                                                                                                                                                             |       |               |       |                  |       |
| Current assets:                                                                                                                                                                                                        | ** ** | ** **         | ** ** | ** **            | ** ** |
| Cash                                                                                                                                                                                                                   |       | $                  | 2,502      |                  | $          | 22 |   |
| Accounts receivable, net                                                                                                                                                                                               |       | 134,244            |       | 207,886               |       |
| Inventory                                                                                                                                                                                                              |       | 26,923             |       | 56,666                |       |
| Deferred costs                                                                                                                                                                                                         |       | 12,066             |       | 14,909                |       |
| Other current assets                                                                                                                                                                                                   |       | 8,905              |       | 9,118                 |       |
| Total current assets                                                                                                                                                                                                   |       | 184,640            |       | 288,601               |       |
| Depreciable assets, net                                                                                                                                                                                                |       | 13,153             |       | 13,640                |       |
| Other assets                                                                                                                                                                                                           |       | 3,302              |       | 4,416                 |       |
| Total assets                                                                                                                                                                                                           |       | $                  | 201,095    |                  | $          | 306,657 |   |
|                                                                                                                                                                                                                   |       |               |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                                                                         |       |               |       |                  |       |
| Current liabilities:                                                                                                                                                                                                   |       |               |       |                  |       |
| Borrowings under credit agreement                                                                                                                                                                                      |       | $                  | —     |                  | $          | 48,014 |   |
| Accounts payable                                                                                                                                                                                                       |       | 111,878            |       | 159,038               |       |
| Accrued liabilities                                                                                                                                                                                                    |       | 17,665             |       | 16,634                |       |
| Deferred revenue                                                                                                                                                                                                       |       | 4,720              |       | 3,611                 |       |
| Accrued warranty liabilities                                                                                                                                                                                           |       | 921                |       | 829                   |       |
| Total current liabilities                                                                                                                                                                                              |       | 135,184            |       | 228,126               |       |
| Other liabilities                                                                                                                                                                                                      |       | 3,747              |       | 3,837                 |       |
| Total liabilities                                                                                                                                                                                                      |       | 138,931            |       | 231,963               |       |
|                                                                                                                                                                                                                   |       |               |       |                  |       |
| Commitments and  contingencies                                                                                                                                                                                         |       |               |       |                  |       |
|                                                                                                                                                                                                                   |       |               |       |                  |       |
| Stockholders’ equity                                                                                                                                                                                              |       |               |       |                  |       |
| Common stock - $0.005 par value, 20,000,000 shares authorized;  9,306,084 issued and 9,380,842 outstanding at March 31, 2006; and  9,806,084 issued and 9,442,888 outstanding at December 31, 2005 |       | 49                 |       | 49                    |       |
| Capital in excess of par value                                                                                                                                                                                         |       | 43,056             |       | 42,943                |       |
| Retained earnings                                                                                                                                                                                                      |       | 21,353             |       | 34,396                |       |
| Treasury stock, 425,242 shares at March 31,  2006 and 363,196 shares at December 31, 2005, at cost                                                                                                           |       | (2,294             | )          | (2,694                | )          |
| Total stockholders’ equity                                                                                                                                                                                        |       | 62,164             |       | 74,694                |       |
| Total liabilities  and stockholders’ equity                                                                                                                                                                       |       | $                  | 201,095    |                  | $          | 306,657 |   |

 

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

2

----

**GTSICORP.CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**(Unaudited)(In thousands, except per share data)
| ** **                                           | ** ** | **Three months ended** | ** ** |
|------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                           | ** ** | **March 31,**               | ** ** |
| ** **                                           | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| ** **                                           | ** ** | ** **                       | ** ** | **(restated)** | ** ** |
|                                                 |       |                             |       |   |   |
| SALES                                                |       | $                                | 149,844    |   | $ | 160,677 |   |
|                                                 |       |                             |       |   |   |
| COST OF SALES                                        |       | 133,791                          |       | 142,204 |   |
|                                                 |       |                             |       |   |   |
| GROSS MARGIN                                         |       | 16,053                           |       | 18,473 |   |
|                                                 |       |                             |       |   |   |
| SELLING,  GENERAL & ADMINISTRATIVE EXPENSES |       | 29,719                           |       | 28,291 |   |
|                                                 |       |                             |       |   |   |
| LOSS FROM  OPERATIONS                                |       | (13,666                          | )          | (9,818 | ) |
|                                                 |       |                             |       |   |   |
| INTEREST AND OTHER  INCOME                           |       |                             |       |   |   |
| Interest and other income                            |       | 1,364                            |       | 920 |   |
| Interest and other expense                           |       | (741                             | )          | (191 | ) |
| Interest and other income, net                       |       | 623                              |       | 729 |   |
|                                                 |       |                             |       |   |   |
| LOSS BEFORE  INCOME TAXES                            |       | (13,043                          | )          | (9,089 | ) |
|                                                 |       |                             |       |   |   |
| INCOME TAX  BENEFIT                                  |       | —                           |       | 3,563 |   |
|                                                 |       |                             |       |   |   |
| NET LOSS                                             |       | $                                | (13,043    | ) | $ | (5,526 | ) |
|                                                 |       |                             |       |   |   |
| LOSS PER SHARE                                       |       |                             |       |   |   |
| Basic                                                |       | $                                | (1.41      | ) | $ | (0.61 | ) |
| Diluted                                              |       | $                                | (1.41      | ) | $ | (0.61 | ) |
|                                                 |       |                             |       |   |   |
| WEIGHTED AVERAGE SHARES  OUTSTANDING                 |       |                             |       |   |   |
| Basic                                                |       | 9,265                            |       | 9,002 |   |
| Diluted                                              |       | 9,265                            |       | 9,002 |   |

 

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

3

----

**GTSICORP.CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**(Unaudited)(In thousands)
| ** **                                                                      | ** ** | **Three months ended** | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                      | ** ** | **March 31,**               | ** ** |
| ** **                                                                      | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| ** **                                                                      | ** ** | ** **                       | ** ** | **(restated)** | ** ** |
|                                                                            |       |                             |       |   |   |
| **CASH FLOWS FROM OPERATING  ACTIVITIES:**                                      |       |                             |       |   |   |
| Net loss                                                                        |       | $                                | (13,043    | ) | $ | (5,526 | ) |
| Adjustments to  reconcile net loss to net cash provided by operating activities |       | 63,923                           |       | 31,111 |   |
| Net cash provided by operating activities                                       |       | 50,880                           |       | 25,585 |   |
|                                                                            |       |                             |       |   |   |
| **CASH FLOWS FROM INVESTING  ACTIVITIES:**                                      | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Purchase of  depreciable assets                                                 |       | (642                             | )          | (1,181 | ) |
| Net cash used in investing activities                                           |       | (642                             | )          | (1,181 | ) |
|                                                                            |       |                             |       |   |   |
| **CASH FLOWS FROM FINANCING  ACTIVITIES:**                                      | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Payments on  credit facility                                                    |       | (48,014                          | )          | (1,179 | ) |
| Proceeds from  exercises of stock options                                       |       | 256                              |       | 350 |   |
| Net cash used in financing activities                                           |       | (47,758                          | )          | (829 | ) |
|                                                                            |       |                             |       |   |   |
| NET INCREASE IN  CASH                                                           |       | 2,480                            |       | 23,575 |   |
|                                                                            |       |                             |       |   |   |
| CASH AT  BEGINNING OF PERIOD                                                    |       | 22                               |       | 397 |   |
|                                                                            |       |                             |       |   |   |
| CASH AT END OF PERIOD                                                           |       | $                                | 2,502      |   | $ | 23,972 |   |

 

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

4

----

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

**1.             Basis of Presentation**

Theaccompanying unaudited interim condensed consolidated financial statements ofGTSI Corp. and its subsidiaries (“GTSI” or the “Company”) have been preparedpursuant to the rules and regulations of the Securities and ExchangeCommission for quarterly reports on Form 10-Q and, therefore, omitor condense certain note disclosures and other information required by U.S.generally accepted accounting principles for complete financial statements. Thesefinancial statements should therefore be read in conjunction with the auditedconsolidated financial statements and accompanying notes for the year ended December 31,2005 included in GTSI’s Annual Report on Form 10-K. Investments inwhich the Company does not control the investee but has the ability to exercisesignificant influence over its operating and financial policies are accountedfor using the equity method of accounting.

Inthe opinion of management, the accompanying unaudited condensed consolidatedfinancial statements reflect all adjustments (which are of a normal recurringnature) considered necessary to present fairly GTSI’s financial position as of March 31,2006 and its results of operations and cash flows for the three months ended March 31,2006 and 2005.

Theresults of operations for the three month period ended March 31, 2006 arenot necessarily indicative of the results that may be expected for the fullyear, or future periods. GTSI has historically experienced significant seasonalfluctuations in operations as a result of government buying and fundingpatterns. These patterns historically have had a negative effect on GTSI’ssales and net (loss) income during the quarter ended March 31. Certain priorperiod amounts have been reclassified to conform to the current periodpresentation.

TheCompany has not complied with certain covenants of the Company’s $75 millionrevolving credit facility with a group of banks (the “Credit Agreement”) whichwill terminate on May 31, 2006. A breach of any of the covenants orrestrictions contained in the Credit Agreement would result in an event ofdefault. Such a default could allow the lenders to discontinue lending ordeclare all borrowings outstanding to be due and payable. If any of theseevents occur, there is no assurance that GTSI will have sufficient fundsavailable to pay in full the total amount of obligations that become due as aresult of any such acceleration, or that GTSI will be able to find additionalor alternative financing to refinance any such accelerated obligations. If weare unable to obtain alternative financing prior to the expiration of theCredit Agreement, it would likely have a material adverse affect on ourfinancial condition and ability to continue as a going concern.

**2.****                                     ****Restatement of FinancialStatements**

GTSIrestated its previously issued condensed consolidated financial statements forthe first three quarters of 2005. The restatements are discussed in detail inGTSI’s Annual Report on Form 10-K for the year ended December 31,2005. The restatements for the three months ended March 31, 2005 includedprior period adjustments for the timing of revenue recognition and associatedcost of sales related to the delivery of products directly from the Company’ssuppliers to its customers.

5

----

A summary of the aggregate effect of this priorperiod adjustment on GTSI’s condensed consolidated Statements of Operations isshown below:
| ** **                         | ** ** | **For the three months ended** | ** ** |
|------------------------------------|------------|----------------------------------------------------|------------|
| ** **                         | ** ** | **March 31, 2005**                       | ** ** |
| ** **                         | ** ** | **As Reported**                               | ** ** | **As Restated** | ** ** |
| Sales                              |       | $                                                  | 157,001    |   | $ | 160,677 |   |
| Cost of sales                      |       | $                                                  | 138,922    |   | $ | 142,204 |   |
| Gross margin                       |       | $                                                  | 18,079     |   | $ | 18,473 |   |
| Loss from  operations              |       | $                                                  | (10,212    | ) | $ | (9,818 | ) |
| Income tax  benefit                |       | $                                                  | 3,673      |   | $ | 3,563 |   |
| Net loss                           |       | $                                                  | (5,810     | ) | $ | (5,526 | ) |
| Loss per share, basic  and diluted |       | $                                                  | (0.65      | ) | $ | (0.61 | ) |

 

**3.****                                     ****Stock-Based Compensation**

Asof March 31, 2006, the Company has four stock-based employee compensationplans, which are described below. Prior to January 1, 2006, the Companyaccounted for those plans under the recognition and measurement provisions ofAPB Opinion No. 25, *Accounting for StockIssued to Employees,*(“APB 25”) and related Interpretations, aspermitted by FASB Statement No. 123, *Accounting for Stock-BasedCompensation* (“FAS 123”). No stock-based employee compensation costwas recognized in the condensed consolidated Statement of Operations for thethree months ended March 31, 2005 as all options granted under those planshad an exercise price equal to the market value of the underlying common stockon the date of grant. Effective January 1, 2006, the Company adopted thefair value recognition provisions of FASB Statement No. 123 (R), *Share-Based Payment*, (“FAS 123R”), using themodified-prospective-transition method. Under that transition method, compensationcost recognized in the three months ended March 31, 2006 includes: (a) compensationcost for all share-based payments granted prior to, but not yet vested as of January 1,2006, based on the grant date fair value estimated in accordance with theoriginal provisions of FAS 123, and (b) compensation cost for allshare-based payments granted subsequent to January 1, 2006, based on thegrant-date fair value estimated in accordance with the provisions of FAS 123R. Resultsfor the prior periods have not been restated.

Asa result of adopting FAS 123R on January 1, 2006, the Company’s reportedloss from operations, loss before income taxes and net loss for the threemonths ended March 31, 2006 are $189 thousand lower than if it hadcontinued to account for share-based compensation under APB 25. Basic anddiluted loss per share for the three months ended March 31, 2006 wouldhave been $1.39, if the Company had not adopted FAS 123R, compared to reportedbasic and diluted loss per share of $1.41.

Priorto the adoption of FAS 123R, the Company presented all tax benefits ofdeductions resulting from the exercise of stock options as operating cash flowsin the condensed consolidated Statement of Cash Flows. FAS 123R requires thecash flows resulting from the tax benefits resulting from tax deductions inexcess of the compensation cost recognized for those options (excess taxbenefits) to be classified as financing cash flows. Since there was no taxbenefit for stock options during the three months ended March 31, 2006, therewas no impact on the Company’s Statement of Cash Flows for the adoption of FAS123R.

Thefollowing table illustrates the effect on net loss and loss per share if theCompany had applied the fair value recognition provisions of FAS 123 to optionsgranted under the Company’s stock option plans for the three months ended March 31,2005. For purposes of this pro forma disclosure, the value of the options isestimated using a Black-Scholes-Merton option-pricing formula and amortized toexpense over the options’ vesting periods, as a single award.

6

----

 
| ** **                                                                                                                                                             | ** ** | **Three months ended** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                                                                                             | ** ** | **March 31, 2005**     | ** ** |
| ** **                                                                                                                                                             | ** ** | **(restated)**                   | ** ** |
| Net loss — as  reported                                                                                                                                           |       | $                                | (5,526     | ) |
| Deduct: Total  stock-based employee compensation expense determined under the  fair value based method for all awards, net of related  tax effects |       | (682                             | )          |
| Net loss — pro  forma                                                                                                                                             |       | $                                | (6,208     | ) |
|                                                                                                                                                                   |       |                             |       |
| Loss per share,  basic and diluted — as reported                                                                                                                  |       | $                                | (0.61      | ) |
|                                                                                                                                                                   |       |                             |       |
| Loss per share, basic  and diluted — pro forma                                                                                                                    |       | $                                | (0.69      | ) |

 

*Stock-based Employee CompensationPlans*

TheCompany has two stockholder approved combination incentive and non-statutorystock incentive plans: the 1994 Stock Option Plan, as amended (“1994 Plan”),and the Amended and Restated 1996 Stock Incentive Plan (“1996 Plan”). Theseplans provide for the granting of options to employees (both plans) andnon-employee directors (only under the 1996 Plan) to purchase up to 3,500,000and 300,000 shares, respectively, of the Company’s common stock. The 1996 Planalso permits the grant of restricted stock units to its employees andnon-employee directors. The Company has another stockholder approved plan, the1997 Non-Officer Stock Option Plan (the “1997 Plan”), which provides for thegranting of non-statutory stock options to employees (other than officers anddirectors) to purchase up to 300,000 shares of the Company’s common stock. Inaddition, GTSI has utilized a vehicle permitted under NASDAQ marketplace rules thatallows a company without stockholder approval to offer stock options toprospective employees as an inducement to join GTSI (the “CapitalizationVehicle”).

Underthe 1997, 1996, and 1994 Plans, options have a term of up to ten years,generally vest over four years and option prices are required to be at not lessthan 100% of the fair market value of the Company’s common stock at the date ofgrant and, except in the case of non-employee directors, must be approved bythe Board of Directors or its Compensation Committee. Options issued under theCapitalization Vehicle have a term of seven years, vest over four years andoption prices equal the fair market value of the Company’s common stock on thedate of approval by the Board of Directors. The vesting period for restrictedstock and restricted stock units is determined by the Compensation Committee onan individual award basis. GTSI recognizes stock-based compensation expense forthese graded vesting awards on a straight-line basis over the requisite serviceperiod for the entire award, which is equal to the vesting period specified inthe option agreement.

*Valuation Assumptions*

Thefair value of each option award is estimated on the date of grant using aBlack-Scholes-Merton option valuation model that uses the assumptions noted inthe following table. Expected volatilities are based on the historicalvolatility of GTSI’s stock. The Company uses historical data to estimate optionexercises and employee terminations within the valuation model. The expectedterm of options granted has been determined based on historical exercisebehavior and represents the period of time that options granted are expected tobe outstanding. The risk-free interest rate is based on the five year U.S.Treasury rates at the time of grant which approximates GTSI’s 4.8 year expectedterm of the option.

7

----

** **

|                           | ** ** | **Three months ended** | ** ** |
|---------------------------|------------|----------------------------------|------------|
| ** **                | ** ** | **March 31, 2006**     | ** ** |
| Expected  volatility      |       | 50.1                             | %          |
| Expected  dividends       |       | —                           |       |
| Expected term  (in years) |       | 4.8                              |       |
| Risk-free rate            |       | 4.6                              | %          |

* *

*StockOptions*

A summary of option activity under the Company’sstock incentive plans as of March 31, 2006 and changes during the periodthen ended is presented below:
| **Options**                          | ** ** | ** ** | ** ** | **Shares  (000)** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Weighted-  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value  ($000)** | ** ** |
|--------------------------------------|------------|------------|------------|-------------------|------------|-----------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------|------------|
|                                 |       |       |       |              |       |                                    |       |                                                 |       |
| Outstanding at  January 1, 2006 |       | 2,088      |       | $                 | 8.57       |                                    |       |                                                 |       |                                    |
| Granted                              |       | 10         |       | $                 | 6.61       |                                    |       |                                                 |       |                                    |
| Exercised                            |       | (123       | )          | $                 | 4.34       |                                    |       |                                                 |       |                                    |
| Forfeited                            |       | (92        | )          | $                 | 7.87       |                                    |       |                                                 |       |                                    |
| Expired                              |       | (69        | )          | $                 | 10.34      |                                    |       |                                                 |       |                                    |
| Outstanding at  March 31, 2006  |       | 1,814      |       | $                 | 8.81       |                                    | 4.1        |                                                 | $          | 768                                     |       |
| Exercisable at  March 31, 2006  |       | 1,610      |       | $                 | 8.90       |                                    | 3.8        |                                                 | $          | 768                                     |       |

 

Theweighted-average grant-date fair value of options granted during the threemonths ended March 31, 2006 and 2005 was $3.16 and $4.70, respectively. Thetotal intrinsic value of options exercised during the three months ended March 31,2006 and 2005 was $369 thousand and $240 thousand respectively. Cash receivedfrom option exercises under all share-based payment arrangements for the threemonths ended March 31, 2006 and 2005 was $256 thousand and $350 thousand,respectively. The tax benefit for the tax deductions from option exercises ofthe share-based payment arrangements totaled zero and $94 thousand for thethree months ended March 31, 2006 and 2005, respectively. The Company hashistorically issued shares from treasury stock to satisfy option exercises.

*Restricted Shares*

The fair value of nonvested shares of restricted stock is determinedbased on the closing trading price of the Company’s shares on the grant date.There were no restricted stock units granted during the three months ended March 31,2005. A summary of the status of Company’s nonvested shares as of March 31,2006, and changes during the period ended March 31, 2006, is presentedbelow:

| Nonvested Shares              | ** ** | ** **    | ** ** | **Shares  (000)** | ** ** | **Weighted-Average  Grant-Date Fair Value** | ** ** |
|------------------------------------|------------|---------------|------------|-------------------|------------|-------------------------------------------------------|------------|
| Nonvested at  January 1, 2006 |       | 50            |       | $8.16             |       |
| Granted                            |       |   2 |       | $7.20             |       |
| Nonvested at  March 31, 2006  |       | 52            |       | $8.13             |       |

 

*Unrecognized Compensation*

Asof March 31, 2006, there was $1.6 million of total unrecognizedcompensation cost related to nonvested stock-based awards. That cost is expectedto be recognized over a period of 4.1 years. During the three months ended March 31,2006, approximately 6 thousand awards vested.

8

----

*Options Exercised*

During the three months ended March 31, 2006,122,500 stock options were exercised under the Company’s stock option plans.These shares were issued from treasury stock.

**4.****                                     ****Inventory**

Inventoryis valued at the lower of cost or market. The Company writes down its inventoryfor obsolete or excess inventory based on assumptions about future demand andmarket conditions by recording a reserve to Inventory on the balance sheet. Asof March 31, 2006, the balance of the reserve was $4.1 million.

**5.****                                     ****Credit Facility**

Asof December 31, 2005, the Company had a $135 million revolving creditfacility with a group of lenders (the “Credit Facility”). As of January 31,2006, the Company defaulted on three financial covenants under the CreditFacility and its lenders requested the execution of an agreement to temporarilyforbear them from enforcing their rights and remedies as a result of the eventsof default. During the three months ended March 31, 2006, a forbearanceagreement (the “Credit Agreement”) was executed between GTSI and its lenders.Under the terms of the Credit Agreement, the lenders agreed to forbear fromexercising their rights and remedies against GTSI in respect of certainexisting defaults under the Credit Facility and to continue to advance funds tothe Company until May 31, 2006, unless GTSI is in breach of the CreditAgreement at an earlier date. As required by the Credit Agreement, the Companypaid a $225 thousand fee to the lenders. Under the Credit Agreement the size ofthe Credit Facility was decreased to $75 million and the interest rate wasincreased to LIBOR plus 3.0% per annum. As of March 31, 2006, GTSI hadavailable credit of $34.9 million under the Credit Agreement.

Asof March 31, 2006, GTSI was not in compliance with the minimum financialnet worth financial covenant in the Credit Agreement. In addition, on April 3,2006, GTSI defaulted on another covenant under the Credit Agreement when theCompany received a staff determination letter from the NASDAQ National Marketstating that, because GTSI had not filed its Annual Report on Form 10-Kfor 2005 with the SEC, its common stock was subject to delisting from theNASDAQ National Market. Upon the filing of GTSI’s Form 10-K for 2005on April 12, 2006, NASDAQ issued a letter stating the Company was incompliance with the listing rules.

OnApril 10, 2006, the Company signed a commitment letter to negotiate a newrevolving credit facility with two major U.S. banks by May 31, 2006. TheCompany and the lenders are working to complete their due diligence efforts andmanagement plans to execute a new revolving credit facility agreement prior to June 1,2006.

**6.             Earnings Per Share**

Basicearnings (loss) per share are calculated by dividing net income or loss by theweighted average shares outstanding during the period, which includes shares ofrestricted stock that are fully vested. 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.

Antidilutive employee stock options totaling 231 thousand and 572thousand have been excluded for the three months ended March 31, 2006 and2005, respectively. Unvested restricted stock units totaling 51 thousand shareshave been excluded for the three months ended March 31, 2006.

9

----

7**.             IncomeTaxes**

TheCompany has provided a valuation allowance against the full amount of the netdeferred tax assets at March  31, 2006 because, in the opinion ofmanagement, it is more likely than not that these deferred tax assets will notbe realized. Therefore, no income tax benefit was reported in the Statement ofOperations on the loss before income taxes of $13.0 million for the threemonths ended March 31, 2006.

**8.             Commitments andContingencies**

*ProductWarranties*

GTSI offers extended warranties on certain products which are generallycovered for three or five years beyond the warranty provided by themanufacturer. Products under extended warranty require repair or replacement ofdefective parts at no cost to the customer. The Company records warrantyliabilities at the time of sale for the estimated costs that may be incurredunder its extended warranty contracts. The following table summarizes theactivity related to product warranty liabilities (in thousands):
| ** **                                          | ** ** | **Three months ended** | ** ** |
|-----------------------------------------------------|------------|----------------------------------|------------|
| ** **                                          | ** ** | **March 31,**               | ** ** |
| ** **                                          | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| Accrued  warranties at beginning of period          |       | $                                | 829        |   | $ | 2,429 |   |
| Charges made  against warranty liabilities          |       | (96                              | )          | (319 | ) |
| Change in  estimate of accrued warranty liabilities |       | 188                              |       | (196 | ) |
| Accruals for  additional warranties sold            |       | —                           |       | 101 |   |
| Accrued warranties at  end of period                |       | $                                | 921        |   | $ | 2,015 |   |

 

Revenue and Cost of Sales from extended warranty contracts is recordedas Deferred Revenue and Deferred Costs, respectively, and subsequentlyrecognized over the term of the contract. The following table summarizes theactivity related to the deferred warranty revenue (in thousands):
| ** **                                        | ** ** | **Three months ended** | ** ** |
|---------------------------------------------------|------------|----------------------------------|------------|
| ** **                                        | ** ** | **March 31,**               | ** ** |
| ** **                                        | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| Deferred  warranty revenue at beginning of period |       | $                                | 1,361      |   | $ | 2,599 |   |
| Deferred  warranty revenue recognized             |       | (279                             | )          | (367 | ) |
| Revenue deferred  for additional warranties sold  |       | —                           |       | 53 |   |
| Deferred warranty  revenue at end of period       |       | $                                | 1,082      |   | $ | 2,285 |   |

 

*Letters of Credit*

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

Asof December 31, 2005, GTSI had an outstanding letter of credit to acustomer in the amount of $1.75 million to guarantee the performance by theCompany of all obligations under the contract. This obligation expired on February 28,2006.

*Employment Agreements*

Asof December 31, 2005, the Company had an employment agreement with itsformer Chief Executive Officer which provided for payment of $0.7 million upontermination of employment. This agreement

10

----

wasterminated on February 15, 2006 when the Company entered into a transitionagreement with its former CEO (the “Transition Agreement”). The TransitionAgreement provides for a payment of $1.1 million to be paid out over the next18 months, as well as reimbursement for certain benefits and legal fees. As aresult, the Company recorded a severance liability, which is included inAccrued Liabilities, of $1.2 million during the three months ended March 31,2006. The related charge increased Selling, General & Administrativeexpenses by $1.2 million for the three months ended March 31, 2006.

OnFebruary 16, 2006, GTSI entered into an employment agreement with theCompany’s current President and Chief Executive Officer. This agreementprovides for payments of 12 months of base salary plus bonus equal to theprevious year’s bonus payments upon termination of employment or a change incontrol. In addition, GTSI has change in control agreements with 15 additionalexecutives and key employees. These arrangements provide for payments of asmuch as 18 months of total target compensation and continuation of benefitsupon the occurrence of specified events. As of March 31, 2006 no accrualshave been recorded for these agreements.

*Contingencies*

Currently,and from time to time, GTSI is involved in litigation incidental to the conductof its business. As of March 31, 2006, GTSI is not a party to any lawsuitor proceeding that, in the opinion of management, is likely to have a materialadverse effect on its financial position or results of operations.

**9.             Subsequent Events**

GTSI’sBoard of Directors (the “Board”) approved on April 28, 2006 the followingbonus payments, short-term incentive program, and severance agreements for theCompany’s executive officers in an effort to promote retention and performancein 2006 and beyond:

1)              First quarter cash bonus payments for GTSI’sCEO, CFO, Executive VP of Sales, Chief Marketing Officer, and Group VP of IT &Operations for approximately $0.2 million in recognition of efforts to enhancethe Company’s financial position, provide leadership and regarding othersignificant corporate matters. Pursuant to similar arrangements the Company isproviding bonuses to promote retention and performance to all other eligibleemployees for the first quarter of 2006. Incentive expense for executiveofficers and other employees totaling $0.5 million was accrued during the threemonths ended March 31, 2006 and reported in GTSI’s Statement of Operationsas Selling, General & Administrative expenses;

2)              A short term incentive program forapproximately 25 key employees, including the Company’s Executive Officers, toencourage efforts in enhancing GTSI’s financial performance and stockholdervalue. The program will be funded with an amount equal to 10% of GTSI’searnings before taxes, if any, for the year ending December 31, 2006; and

3)              Severance payments consisting of six monthsof base salary, if terminated without cause, for GTSI’s CFO, Executive VP ofSales, Chief Marketing Officer and Group VP of IT & Operations.

11

----

**ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS**

Thefollowing discussion and analysis is provided to increase the understanding of,and should be read in conjunction with, our unaudited condensed consolidated financialstatements and notes included in Part I, Item 1 of this Quarterly Reporton Form 10-Q and our consolidated financial statements and notes inour Annual Report on Form 10-K for the year ended December 31,2005. We use the terms “GTSI,” “we,” “our,” and “us” to refer to GTSI Corp. andits 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 these forward-lookingstatements. These statements are not guarantees of future performance and aresubject to risks, uncertainties and assumptions that are difficult to predict. Therefore,actual results in future periods may differ materially from those expressed orprojected in any forward-looking statements because of a number of risks anduncertainties, including:

·                  Theuncertainty surrounding our ability to meet the covenants under our Credit Agreementin future periods and to obtain alternative financing for our future capitalneeds;

·                  Infrastructurefailures;

·                  Ourexposure to inventory risks;

·                  Changesin our management team, including our former Chief Executive Officer whoresigned February 15, 2006;

·                  Materialweaknesses in our internal control over financial reporting;

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

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

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

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

·                  Ourability to attract and retain talented employees;

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

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

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

·                  Competitionand loss of market share;

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

·                  Changesin Federal government fiscal spending.

12

----

For a detailed discussion of risk factors affecting GTSI’s business andoperations, see Item 1A, Risk Factors in our Annual Report on Form 10-Kfor the year ended December 31, 2005. We undertake no obligation to reviseor update any forward-looking statements for any reason.

**Restatement**

Asmore fully described in Note 2 of our unaudited condensed consolidatedfinancial statements of this Quarterly Report on Form 10-Q, werestated our condensed consolidated Balance Sheet and Statement of Operationsfor the quarter ended March 31, 2005 to correct the timing of revenuerecognition and associated cost of sales related to the delivery of productsdirectly from our suppliers to our customers. All accounting informationincluded in Management’s Discussion and Analysis of Financial Condition andResults of Operations reflect the restatement.

**Overview**

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

Thevast majority of the IT solutions we offer to our customers have a strongproduct component, and many are entirely product-based. We connect IT’s leadingvendors, products and services inside the core technology areas most criticalto government success by partnering with global IT leaders such as Panasonic,HP, Cisco and Sun Microsystems. In our traditional reseller capacity, weprovide government with products for workgroup computing, such as workstationsand desktops; mobility computing and communications, such as wireless-equippednotebooks and PDAs; core computing, such as servers, high-end computing, andstorage systems; networking products; and a wide range of peripherals.

During2005, we began focusing on application areas in which our government customershave consistently demonstrated the greatest immediate strategic interest, andwhich provide us with the greatest opportunity for sustained return oninvestment. Our primary solution attention is being directed toward ITconsolidation, disaster recovery and backup, e-mail management, and visualcommunication support for remote workers and distributed offices, includingcollaboration, presentation, and broadcast systems.

Tohelp our customers acquire, manage and refresh this technology in a strategicand application-appropriate manner, GTSI has created a mix of financialservices capable of managing the entire technology lifecycle. We offer leasingarrangements to allow government agencies to acquire access to technology as anevenly distributed operating expense, rather than the much morebudget-sensitive and discontinuous capital expenditures. This model is in highdemand from our customers, and we believe it represents a distinctive advantage.We expect to continue to expand our sales from leasing arrangements for ITproducts and solutions in 2006.

Asdiscussed in more detail throughout our MD&A for the three months ended March 31,2006 compared to March 31, 2005:

·                  TotalSales declined $10.8 million;

·                  GrossMargin as a percentage of sales decreased 80 basis points;

·                  NetLoss for the three months ended March 31, 2006 was $13.0 million, predominantlyrelated to lower Sales and increased Selling, General & Administrativeexpenses of $1.4 million; and

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

13

----

Weare looking forward to significant improvements in operational and financialperformance through a combination of additional sales and improved marginpercentages. We have put in place a multi-element plan to move the businessfrom lower margin product sales to higher margin solutions sales. In the firstelement of our plan, we identified and exited failing or non-strategicactivities, including two reductions in workforce totaling over 100 full timepositions and realigning functions throughout GTSI to increase marginimprovement through cost reductions. In the second and third elements of ourplan, which will progress throughout 2006, we will work to improve execution ofthe current business and deliver high value solutions. We believe there aresignificant opportunities to increase our relatively low market share withinthe government IT market as we pursue a distinctive business model combiningthe concepts of a value added provider of complex IT solutions with atraditional reseller.

**CriticalAccounting Estimates and Policies**

Ourunaudited condensed consolidated financial statements are based on theselection of accounting policies and the application of significant accountingestimates, some of which require management to make significant assumptions. Webelieve that some of the more critical estimates and related assumptions thataffect our financial condition and results of operations pertain to revenuerecognition, valuation of inventory, capitalized internal use software andaccounts payable. For more information on critical accounting estimates andpolicies see the MD&A included in our Annual Report on Form 10-Kfor the year ended December 31, 2005. We have discussed the application ofthese critical accounting estimates and policies with the Audit Committee ofour Board of Directors.

Weadopted SFAS No. 123 (Revised 2004), *Share-Based Payment*(“FAS 123R”) as of January 1, 2006 and as a result, we changed theaccounting for our stock option plans from the intrinsic value method, usedprior to 2006, to the fair value method as required by FAS 123R. We adopted FAS123R using the modified prospective transition method. As a result of theadoption, our stock-based compensation expense increased $0.2 million duringthe three months ended March 31, 2006, which was recorded as Selling,General & Administrative expenses on our condensed consolidatedStatement of Operations. In accordance with the modified-prospective-transitionmethod, our consolidated financial statements for prior periods have not beenrestated to reflect, and do not include, the impact of FAS 123R. There was nostock-based compensation expense related to employee stock options recognizedduring the three months ended March 31, 2005 because the exercise price ofthe stock options granted to employees and directors equaled the fair marketvalue of the underlying stock on the date of grant.

Weexpect that the adoption of FAS 123R will result in additional expenses, ascompared to 2005, of approximately $0.7 million for the unvested stock optionsoutstanding at December 31, 2005. We are unable to predict the ultimateimpact to our operations, as it will depend on the level of share-based awardsin 2006 and thereafter, and the actual rate of forfeitures, as compared to ourestimate of forfeitures.

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

14

----

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

Asstock-based compensation expense recognized in the condensed consolidatedStatement of Operations for the first quarter of 2006 is based on awardsultimately expected to vest, it has been reduced for estimated forfeitures.Forfeitures were estimated based on historical experience. As of March 31,2006, the total compensation cost related to nonvested awards not yetrecognized was $1.6 million, which will be recognized over a period of 4.1years.

Duringthe year ended December 31, 2005, the Company’s Board of Directorsapproved the acceleration of the vesting of unvested stock options with anexercise price higher than $8.09, the market value on the date of theacceleration, previously awarded to employees, officers and directors underGTSI’s stock option plans. This action affected unvested options to purchase anaggregate of 515 thousand shares of common stock at exercise prices per sharebetween $8.23 and $13.67. The vesting of these options was accelerated to avoidrecognizing compensation expense in future financial statements upon theadoption of FAS 123R.

**Historical Results of Operations**

The following table illustrates the unaudited percentage of salesrepresented by items in our condensed consolidated statements of operations forthe periods presented.
| ** **                                           | ** ** | **Three months ended**             | ** ** |
|------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                           | ** ** | **March 31.**                           | ** ** |
| ** **                                           | ** ** | **   2006   ** | ** ** | **   2005   ** | ** ** |
|                                                 |       |                                         |       |   |   |
| Sales                                                |       | 100.0                                        | %          | 100.0 | % |
| Cost of sales                                        |       | 89.3                                         |       | 88.5 |   |
| Gross margin                                         |       | 10.7                                         |       | 11.5 |   |
| Selling,  general & administrative expenses |       | 19.8                                         |       | 17.6 |   |
| Loss from  operations                                |       | (9.1                                         | )          | (6.1 | ) |
| Interest and other  income, net                      |       | 0.4                                          |       | 0.4 |   |
| Loss before  income taxes                            |       | (8.7                                         | )          | (5.7 | ) |
| Income tax  benefit                                  |       | —                                       |       | 2.3 |   |
| Net loss                                             |       | (8.7                                         | )%         | (3.4 | )% |

 

The following tables indicate, for the periodsindicated (dollars in millions), the approximate sales by type and vendor alongwith related percentages of total sales.
| **Sales by Type**          | ** ** | **Three months ended March 31,** | ** ** |
|--------------------------------------|------------|------------------------------------------------------|------------|
| ** **                           | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| Hardware, net of  reserves           |       | $                                                    | 107.4      |   | 71.7 | % | $ | 128.7 |   | 80.1 | % |
| Software                             |       | 22.6                                                 |       | 15.1 |   | 21.4 |   | 13.3 |   |
| Resold  third-party service products |       | 13.1                                                 |       | 8.7 |   | 7.3 |   | 4.5 |   |
| Services                             |       | 6.7                                                  |       | 4.5 |   | 3.3 |   | 2.1 |   |
| Total                                |       | $                                                    | 149.8      |   | 100.0 | % | $ | 160.7 |   | 100.0 | % |

 

15

----

 
| **Sales by Vendor** | ** ** | **Three months ended March 31,** | ** ** |
|-------------------------------|------------|------------------------------------------------------|------------|
| ** **                    | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| Panasonic                     |       | $                                                    | 33.5       |   | 22.4 | % | $ | 39.5 |   | 24.6 | % |
| Cisco                         |       | 24.7                                                 |       | 16.5 |   | 17.0 |   | 10.6 |   |
| HP                            |       | 16.2                                                 |       | 10.8 |   | 19.1 |   | 11.9 |   |
| Sun Microsystems              |       | 10.9                                                 |       | 7.3 |   | 18.4 |   | 11.5 |   |
| Network  Appliance            |       | 3.6                                                  |       | 2.4 |   | 3.5 |   | 2.2 |   |
| Other, net of  reserves       |       | 60.9                                                 |       | 40.6 |   | 63.2 |   | 39.2 |   |
| Total                         |       | $                                                    | 149.8      |   | 100.0 | % | $ | 160.7 |   | 100.0 | % |

 

**Three Months Ended March 31, 2006 Compared With the Three MonthsEnded March 31, 2005**

*Sales*

Salesconsist of revenue from products delivered and services sold or rendered, netof allowances for customer returns. Sales for the first quarter of 2006declined $10.8 million, or 6.7 %, compared to the same period in 2005. Reasonsfor the sales declines are consistent with the trends we experienced during thelatter part of 2005 and include weak performance associated with certain salesteams and vendor lines resulting in decreased bookings during the fourthquarter of 2005. Sales to certain government agencies and of vendor productlines were below previous periods, and we have taken steps to align theresources in the organization with the margin potential. Our sales were weakerthan we expected, due to a $4.6 million higher backlog as of March 31,2006 than as of December 31, 2005.

Ananalysis of sales by type indicates all categories increased quarter overquarter except for hardware sales, which decreased $21.3 million. Resoldthird-party service products increased $5.8 million, services increased $3.4million, and sales of software increased $1.2 million during the three monthsended March 31, 2006, compared to the three months ended March 31,2005. Services revenue during the three months ended March 31, 2006 morethan doubled to $6.7 million and exceeded budget for the quarter withimprovements in revenue and gross margin. These results are consistent with ourplans to increasingly become a high-end solutions provider.

Managementintends to increase sales under lease agreements 50% during the year ending December 31,2006. We achieved record Sales with our U.S. Communities contract, which wasrenewed in April 2006 for an additional two years. As a result, managementexpects our sales to state and local governments to continue to increase as apercentage of our total sales.

Otherthan sales of Cisco, our sales from our other top four vendors declined quarterover quarter. Our $10.8 million decrease in sales mainly comprised a $7.5million, or 40.8 %, decrease in Sun Microsystems sales and a $6.0 million, or15.2%, decrease in sales of our top vendor, Panasonic. In addition, sales from Othervendors, net of reserves, decreased $2.3 million quarter over quarter. Thesedeclines were partially offset by the $7.7 million increase in Cisco during thethree months ended March 31, 2006. Although sales remained relativelyconsistent for the first quarter of 2006 and 2005, Network Appliance became oneof our top five vendors for the first time this quarter, exceeding sales ofDell and Microsoft. We believe total Sales for the three months ending June 30,2006 will be comparable to those recognized in the same period in 2005.

*Backlog*

Werecognize an order as backlog when we receive and accept a written customerpurchase order. Our total backlog includes orders that have not shipped (“unshippedbacklog”) as well as orders that have shipped but cannot be recognized as salesat the period end due to our shipping terms and revenue

16

----

recognitionrules. Total backlog increased $4.6 million, or 3.6%, from $127.3 million at December 31,2005 to $131.9 million at March 31, 2006 primarily due to the unshippedbacklog increased of $3.0 million to $129.0 million at March 31, 2006,compared to $126.0 million at December 31, 2005. Backlog fluctuatessignificantly from period to period due to the seasonality of governmentordering patterns and fluctuations in inventory availability of variousproducts.

*Gross Margin*

GrossMargin is Sales less Cost of Sales, which includes product cost, freight,warranty maintenance cost and certain other expenses related to the cost ofacquiring products. Gross margin dollars decreased $2.4 million, or 13.1%, from$18.5 million for the three-month period ended March 31, 2005 to $16.1million for the three months ended March 31, 2006. This decrease was dueto the $10.8 million decline in Sales, partially offset by the correspondingdecrease in Cost of Sales of $8.4 million. The Cost of Sales decrease wasrelated to fewer products delivered in the first quarter of 2006 and lowervendor incentive funds of $1.6 million. Gross Margin as a percentage of salesdeclined 0.8 of a percentage point to 10.7% in the first quarter of 2006 from11.5% in the first quarter of 2005. This decline was due to the 38.1% declinein vendor incentive funds which are recorded as a reduction of Cost of Sales. Vendorincentive funds declined due to decreased sales period over period and changesin vendor incentive fund programs. Gross margin percentages vary over time andmay change significantly depending on our customers’ use of available contractvehicles and the mix of products sold. We expect to increase our gross marginas a percentage of sales as we increase the services content of our orders andselectively bid on contracts with higher engineering and services content.

*Selling, General &Administrative Expenses*

Duringthe three months ended March 31, 2006, Selling, General &Administrative (“SG&A”) expenses increased $1.4 million, or 5.0%, from thesame period in 2005. This increase is primarily due to a $1.2 million severanceexpense under the terms of the transition agreement with our former CEO. Inaddition, commission expense increased $0.6 million, despite the $10.8 milliondecrease in Sales, due to increased compensation to our sales professionalsunder the 2006 Commission Plan. SG&A expenses increased $0.3 million forstock-based compensation for our restricted stock awards and for stock optionsupon the adoption of FAS 123R. During the three months ended March 31,2005, we did not record any stock-based compensation, as we previouslyaccounted for stock options based on the intrinsic value method and we did notgrant restricted stock until the second quarter of 2005. Incentive expenseincreased $0.6 million and bad debt expense increased $0.4 million during thefirst quarter of 2006 over the same period of last year. The increase inincentive expense related to the accrual for bonuses to our executive officersand other eligible employees in an effort to promote retention and performancein 2006 and beyond. SG&A expense increased $0.3 million due to additionaldepreciation.

Theseincreases were offset by decreases of $0.9 million of training and $0.2million, or 1.5%, of salary expenses as a result of the reduction in workforcein October 2005. Training expense was higher during the three months endedMarch 31, 2005 due to preparation for the implementation of GEMS in April 2005.Expressed as a percentage of total sales, SG&A expenses increased from17.6% during the three months ended March 31, 2005 to 19.8% for the sameperiod of the current year. Management is committed to reducing our expenses tomatch our sales and gross margin forecasts. We plan to reduce SG&A expenseas a percentage of sales by approximately 8% by the end of 2006.

*Interest and Other Income, Net*

Interestand Other Income net of interest and other expense, decreased 14.5%, during thethree months ended March 31, 2006 compared to the same period in 2005. Interestand Other Income increased $0.4 million due mainly to increased lease-relatedinterest as a result of higher lease arrangement sales. This increase wasoffset by a $0.6 million increase in Interest and Other Expense due toincreased fees, higher borrowings, and a higher interest rate under our CreditAgreement. Management anticipates our lease

17

----

salesand the related interest income will increase over the next few years as ourgovernment customers use lease arrangements to acquire access to technology asan evenly distributed operating expense, instead of discontinuous capital expenditures.

*Income Taxes*

OurIncome Tax Benefit was $3.6 million for the three months ended March 31,2005, at an effective tax rate of 38.7%. As a result of our full valuationallowance on our deferred tax assets, we did not report any income tax benefitduring the three months ended March 31, 2006, despite our $13.0 millionLoss Before Income Taxes.

**SeasonalFluctuations**

Historically in excess of 95% of our annual sales havebeen earned from departments and agencies of the U.S. Federal Government,either directly or indirectly through system integrators to which GTSI is asub-contractor. We have historically experienced, and expect to continue toexperience, significant seasonal fluctuations in our operations as a result ofgovernment buying and funding patterns, which also affect the buying patternsof GTSI’s prime contractor customers. 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’sfiscal year end), and consequently on sales and net income in the third andfourth quarters of each year. Conversely, sales during the first quarter of ourfiscal year have traditionally been the weakest for GTSI, consisting of lessthan 20% of our annual sales. Our SG&A expenses are more level throughoutthe year. As a result, GTSI has historically shown a net loss for the periodended March 31.

Quarterly financial results are also affected by thetiming of contract awards and the receipt of products by our customers. Theseasonality of our business, and the unpredictability of the factors affectingsuch seasonality, makes GTSI’s quarterly and annual financial results difficultto predict and subject to significant fluctuation.

**Liquidityand Capital Resources**

*Cashflows for the three months ended March 31,*
| **(in millions)**                 | ** ** | ** ** | ** ** | **2006** | ** ** | **2005** | ** ** | **Increase  (Decrease)** | ** ** |
|----------------------------------------|------------|------------|------------|----------|------------|----------|------------|--------------------------|------------|
| Cash provided by  operating activities |       | $          | 50.9       |     | $          | 25.6     |       | $                        | 25.3       |   |
| Cash used in  investing activities     |       | $          | (0.6       | )        | $          | (1.2     | )          | $                        | (0.6       | ) |
| Cash used in financing  activities     |       | $          | (47.8      | )        | $          | (0.8     | )          | $                        | 46.9       |   |

 

Duringthe three months ended March 31, 2006, our cash balance increased $2.5million from our 2005 fiscal year end balance, while we reduced our debt. GTSI’scurrent assets are $104.0 million less as of March 31, 2006 when comparedto our prior fiscal balance. This decline is mainly due to decreased AccountsReceivable of $73.6 million as a result of our increased collections effortsduring the first quarter. In addition, we reduced our Inventory on hand by$29.7 million to mitigate our inventory risk by maintaining less inventory onhand and more effectively manage our cash flows.

Duringthe three months ended March 31, 2006 and 2005 we made capitalexpenditures of $0.6 million and $1.2 million, respectively, primarily forconsulting costs associated with the preparation for a future release of GEMSand the implementation of GEMS in April 2005, respectively. This resultedin a decrease in cash used in investing activities of 45.6% during the threemonths ended March 31, 2006 from the same period of the prior year.

18

----

Duringthe first quarter of 2006, we were able to fully pay our Borrowings Under ourCredit Facility. Cash used in financing activities increased $46.9 millionquarter over quarter, predominantly due to the higher outstanding balance underthe Credit Facility as of December 31, 2005 as compared to December 31,2004.

*Credit Facility*

Asof December 31, 2005, GTSI had a $135 million revolving credit facilitywith a group of lenders, (the “Credit Facility”). As of January 31, 2006,we defaulted on three financial covenants under the Credit Facility and ourlenders requested the execution of an agreement to temporarily forbear themfrom enforcing their rights and remedies as a result of the events of default.During the three months ended March 31, 2006, a forbearance agreement (the“Credit Agreement”) was executed between GTSI and our lenders. Under the termsof the Credit Agreement, the lenders agreed to forbear from exercising theirrights and remedies against GTSI in respect of certain existing defaults underthe Credit Facility and to continue to advance funds to us until May 31,2006, unless we are in breach of the Credit Agreement at an earlier date. Asrequired by the Credit Agreement, we paid a $225 thousand fee to our lenders. Underthe Credit Agreement the size of the Credit Facility was decreased to $75million and the interest rate was increased to LIBOR plus 3.0% per annum. As ofMarch 31, 2006, we had available credit of $34.9 million under the CreditAgreement.

Asof March 31, 2006, GTSI was not in compliance with the minimum financialnet worth financial covenant in the Credit Agreement. In addition, on April 3,2006, GTSI defaulted on another covenant under the Credit Agreement when we receiveda staff determination letter from the NASDAQ National Market stating thatbecause we had not filed our Annual Report on Form 10-K for 2005with the SEC, our common stock was subject to delisting from the NASDAQNational Market. Upon the filing of GTSI’s Form 10-K for 2005 on April 12,2006, NASDAQ issued a letter stating we were in compliance with the listingrules.

*Capital 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. GTSI recorded a net loss of $13.0 million for the three monthsended March 31, 2006. Despite this fact, we were able to maintain positivecash flow from operations due to our intense collection efforts during thequarter. We anticipate that we will continue to rely primarily on operatingcash flow and a replacement revolving credit facility to finance our operatingcash needs. Even though GTSI has experienced a significant loss in the firstquarter of 2006, we believe that such funds should be sufficient to satisfy ournear term anticipated cash requirements for operations, assuming we aresuccessful at structuring a new revolving credit facility prior to theexpiration of our existing Credit Agreement on May 31, 2006.

Wecontinue to have discussions with lenders related to structuring a newrevolving credit facility and on April 10, 2006 we signed a commitmentletter to negotiate a new revolving credit facility with two major U.S. banksby May 31, 2006, the expiration date of the current Credit Facility.However, if we are not able to generate positive cash flow during the remainderof the year and we continue to default on the debt covenants, our revolvingCredit Agreement may be further restricted or terminated. We may seekadditional sources of capital, including obtaining permanent financing over alonger term at fixed rates, to finance our working capital requirements orother strategic initiatives. If we are unable to obtain alternative financing,it would likely have a material adverse affect on our financial condition andability to continue as a going concern.

19

----

Duringthe three months ended March 31, 2006 our obligation under letters ofcredit decreased $1.8 million to $150 thousand as a result of the expiration ofa letter of credit to a customer upon successful completion of a physicalsecurity project. Our contractual obligations under our operating leases as of March 31,2006 are consistent with our year end disclosure in Item 7, MD&A “ContractualObligations” of our 2005 Annual Report on Form 10-K. We have nocommitments to purchase inventory or equipment, nor do we have any off-balancesheet arrangements.

**Outlook**

Weare moving away from the difficulties we experienced during 2005, and ourefforts are focused on creating significant value for our stockholders during2006 and beyond. In February 2006, we separated the positions of Chairmanof the Board and CEO and hired a veteran member of our Board of Directors tofill the newly created President and CEO position. Our current CEO has begunimplementing a turnaround strategy for us and plans to move GTSI away from ourprofile as a reseller toward that of a solution provider. As part of our shiftfrom reseller to solutions provider, GTSI is integrating commercial productswith off-the-shelf software to provide tailored engineering solutions forcustomers.

Theturnaround strategy is focused on stabilizing and improving our supply chain,developing and selling value-added solutions and integration services, andincreasing sales under leasing arrangements. Management feels we have madesteady progress in improving our supply chain process. Our supply chain wasreorganized to report to a single organization under common leadership, to helpsolve some of the supply chain issues which have hindered GTSI since the GEMSimplementation. We anticipate growing our systems engineering and servicesofferings as part of the effort to focus GTSI as a solutions provider, and weplan to focus more on providing solutions to our customers, instead ofcommodity products. Growth in annual sales under leasing arrangements isanticipated as our customers take increasing advantage of the ability tofinance IT investments as recurring operating expenses. In addition to thepriorities in the turnaround strategy, we are also focusing on drivingproductivity throughout the organization.

Whilewe are forecasting sales for the second quarter of 2006 to be consistent withsales during the same period of the prior year, we expect increases in totalsales for 2006 as a result of improvements to our operations from ourstabilized IT platform, improvements in our sales processes, and additionalbusiness due to Northrop Grumman’s shutdown in March 2006 of itsgovernment IT reseller business. We experienced strong booking margin during March 2006,exceeding quota by 22%. This booking margin is expected to translate intoadditional gross margin during the three months ended June 30, 2006. Weare working to bring our expenses more in line with our margin production.Furthermore, we anticipate high industry growth in the areas of storage,networking and physical security translating into additional sales for GTSI.

Webelieve we can make improvements to our operating results during the next threeyears.   We are aggressively tacklingproductivity issues, with the goal to realize significant progress in themonths ahead. These productivity improvements are expected to lower SG&Aexpense as a percentage of sales.

Inanticipation of working capital requirements in the coming months, GTSIobtained a commitment letter from a consortium of banks to negotiate a $125million secured revolving credit facility. We are targeting to close thefacility by May 31, 2006, the expiration date of our Credit Agreement.

20

----

**ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK**

Theinformation required by this item is hereby incorporated by reference to item7A of GTSI’s Annual Report on Form 10-K for the year ended December 31,2005. There have been no material changes in our market risk from thatdisclosed in our Form 10-K.

**ITEM 4.  CONTROLS AND PROCEDURES**

**Evaluation of Disclosure Controls and Procedures**

Anevaluation was carried out under the supervision and with the participation ofour management including our Chief Executive Officer and Chief FinancialOfficer, of the effectiveness of the design and operation of our disclosurecontrols and procedures (as defined in Rules13a-15(e) or 15d-15(e) underthe Securities Exchange Act of 1934, as amended) as of March 31, 2006. Ourdisclosure controls and procedures are designed to (i) ensure thatinformation required to be disclosed by us in reports we file or submit underthe Exchange Act is recorded, processed, summarized and reported within thetime periods specified in the Securities and Exchange Commission’s rules andforms and (ii) is accumulated and communicated to GTSI’s managementincluding our principal executive officer and our principal financial officer,as appropriate to allow timely decisions regarding required disclosures. Basedon this evaluation, our Chief Executive Officer and Chief Financial Officerconcluded that our disclosure controls and procedures were effective as of March 31,2006.

**Changesin Internal Control Over Financial Reporting and Management’s RemediationInitiatives**

Duringmanagement’s assessment of the effectiveness of our internal control overfinancial reporting as of December 31, 2005, we identified three materialweaknesses, which are described in Item 9A of our Annual Report on Form 10-Kfor the year ended December 31, 2005. We are currently addressing theseweaknesses through a number of initiatives as described below.

Withrespect to the material weakness relating to our finance and accountingstaffing, during the three months ended March 31, 2006 funding wasapproved to increase the number of employees in the 

21

----

AccountingDepartment nearly 50% and we are conducting active searches for the newlycreated positions as well as existing openings. We hired employees for two ofthe three key open accounting management positions and used external resourcesto supplement our revenue recognition, accounting for lease transactions andgeneral ledger accounting functions. We plan to continue to use externalconsultants until the hiring and training of permanent staff is completed.Furthermore, the Financial Planning and Analysis Group was separated from theAccounting Department, with each group now reporting directly to the CFO. A newCorporate Controller was hired in April 2006 to oversee the AccountingDepartment.

Weimplemented new procedures for the recording of discrepancy inventory andcustomer sales returns in response to the material weakness relating to ourfinancial close and reporting process. In addition, for all areas in which werecorded post-closing adjustments as of December 31, 2005, we haveexamined the accounting as of March 31, 2006 and recorded similar closingadjustments when appropriate. Subsequent to March 31, 2006, requests forproposal were submitted to several firms for the outsourcing of designingrevised and improved accounting policies and procedures.

Withrespect to the material weakness relating to our customer order fulfillmentprocess, we prepared an analysis similar to the analyses performed for theinterim periods during the year ended December 31, 2005, in order torecord Sales and the related Cost of Sales in the proper period. In addition,our new CEO brought the IT, Customer Service, Distribution, Order Managementand Purchasing Departments under common leadership to help solve some of thesupply chain issues which have hindered GTSI since the GEMS implementation. Additionalresources have been brought into the various groups, processes are beingsystematically tracked, training initiatives are underway and performancemetrics are being developed and reported.

22

----

**PART II — OTHER INFORMATION**

# **Item 3. DefaultsUpon Senior Securities**

Asof January 31, 2006, the Company was not in compliance with three of itsfinancial covenants under its Credit Facility: (i) maximum fundedindebtedness to EBITDA, (ii) minimum EBIT to net sales, and (iii) minimumtangible net worth. As a result, a forbearance agreement (the “Credit Agreement”)was executed to temporarily forbear the lenders from enforcing their rightsunder the Credit Facility and to continue to advance funds to the Company untilMay 31, 2006, unless the Company is in breach of the Credit Agreement atan earlier date.

Asof February 28, 2006 and March 31, 2006, GTSI was not in compliancewith certain financial covenants in the Credit Agreement. In addition, on April 3,2006, GTSI defaulted on another covenant under the Credit Agreement when theCompany received a staff determination letter from the NASDAQ National marketstating that, because GTSI had not filed its Annual Report on Form 10-Kfor 2005 with the SEC, GTSI’s common stock was subject to delisting fromNASDAQ. Upon the filing of GTSI’s Form 10-K for 2005 on April 12,2006, NASDAQ issued a letter stating we were in compliance with the listingrules.

**ITEM 6. EXHIBITS**

The exhibits listed in the Exhibit Indexare filed as part of this Quarterly Report on Form 10-Q.

23

----

**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on May 9, 2006 on its behalf by theundersigned thereunto duly authorized.
|            | ** ** | **GTSI Corp.**                                    |
|------------|------------|---------------------------------------------------|
| ** ** | ** ** |                                              |
| ** ** | ** ** |                                              |
| ** ** | ** ** | /s/ JAMES J. LETO                                 |
| ** ** | ** ** | James J. Leto                                     |
| ** ** | ** ** | President and Chief Executive Officer             |
| ** ** | ** ** |                                              |
| ** ** | ** ** |                                              |
| ** ** | ** ** | /s/ THOMAS A. MUTRYN                              |
| ** ** | ** ** | Thomas A. Mutryn                                  |
| ** ** | ** ** | Senior Vice President and Chief Financial Officer |

 

24

----

**EXHIBIT INDEX**
| Exhibit    | ** ** | ** **                                                                                              |
|------------|------------|---------------------------------------------------------------------------------------------------------|
| **Number** | ** ** | Description                                                                                             | ** ** | ** ** |
| 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) |

 

25

----