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GTSI 10-K 2006

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-K


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

For the fiscal year ended December 31, 2005

Commission File Number:     0-19394

GTSI Corp.

(Exact name of registrant as specified in its charter)

Delaware

 

54–1248422

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer
Identification No.)

3901 Stonecroft Boulevard, Chantilly, VA

 

20151-1010

(Address of principal executive offices)

 

(Zip Code)

 

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

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

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

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

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

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

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

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

Large accelerated filer   o      Accelerated filer   þ      Non-accelerated filer   o

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

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

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

DOCUMENTS INCORPORATED BY REFERENCE

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

 




CONTENTS

 

 

 

 

 

Page

PART I

 

Item 1.

 

Business

 

1

 

 

Item 1A.

 

Risk Factors

 

12

 

 

Item 1B.

 

Unresolved Staff Comments

 

21

 

 

Item 2.

 

Properties

 

21

 

 

Item 3.

 

Legal Proceedings

 

21

 

 

Item 4.

 

Submission of Matters to a Vote of Security Holders

 

21

PART II

 

Item 5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

22

 

 

Item 6.

 

Selected Financial Data

 

23

 

 

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

25

 

 

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

 

37

 

 

Item 8.

 

Financial Statements and Supplementary Data

 

38

 

 

Item 9.

 

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 

 

66

 

 

Item 9A.

 

Controls and Procedures

 

66

 

 

Item 9B.

 

Other Information

 

70

PART III

 

Item 10.

 

Directors and Executive Officers of the Registrant

 

71

 

 

Item 11.

 

Executive Compensation

 

71

 

 

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management

 

71

 

 

Item 13.

 

Certain Relationships and Related Transactions

 

71

 

 

Item 14.

 

Principal Accounting Fees and Services

 

71

 

 

Item 15.

 

Exhibits, Financial Statement Schedules, and Reports on Form 8-K

 

72

 

 

 

 

Signatures

 

73

Schedule II

 

Valuation and Qualifying Accounts

 

75

 

 

 

 

Exhibit Index

 

76

 

 

 




Disclosure Regarding Forward-Looking Statements

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

PART I

ITEM 1.                BUSINESS

Overview

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

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

 

 

2005

 

2004

 

2003

 

U.S. Federal Government

 

 

71

%

 

 

75

%

 

 

80

%

 

Prime Contractors

 

 

21

 

 

 

20

 

 

 

17

 

 

State and Local Governments

 

 

8

 

 

 

5

 

 

 

3

 

 

Total

 

 

100

%

 

 

100

%

 

 

100

%

 

 

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

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

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

1




Communities). We are especially well-positioned to fulfill the requirement of having an appropriate contract vehicle as we hold a contracts portfolio that includes nearly four dozen such contracts, and many major Federal agency-specific contracts.

To fulfill product demand, GTSI maintains a 140,000 square-feet distribution and integration center in Northern Virginia, immediately adjacent to Washington Dulles International Airport. We use this proximity in concert with close systems relationships with our customers and vendors to assure timely delivery for our customers’ mission-critical applications. We leverage our distribution and integration center and matching logistics expertise to offer a wide variety of managed fulfillment and value added services such as:

·       Hardware integration;

·       Customer image propagation;

·       Automated system diagnostics and data capture;

·       Customer asset tagging; and

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

Both our distribution and integration operations are fully ISO certified.

To help our customers acquire, manage and refresh this technology in a strategic and application-appropriate manner, GTSI has created a mix of financial services capable of managing the entire technology lifecycle. GTSI offers lease arrangements to allow government agencies to acquire access to technology as an evenly distributed operating expense, rather than the much more budget-sensitive and discontinuous capital expenses. This is especially important to agencies whose budget planning requirements span many forward-looking years, but whose technology needs cannot be accurately planned on the same timeline. It also appropriately helps agencies keep their information management resources focused on the flow and security of agency information, rather than ownership of the technology itself. This model is in high demand from our customers, and we believe it represents a distinctive GTSI solutions advantage.

Going Concern

Our independent registered public accounting firm, Ernst & Young LLP, has concluded that substantial doubt exists about our ability to continue as a going concern, and has included that conclusion in its audit report on our consolidated financial statements for the year ended December 31, 2005 included in this Annual Report on Form 10-K. GTSI incurred a net loss of $16.0 million for the year ended December 31, 2005 and has not complied with certain covenants of our $135 million revolving credit facility with a group of banks (the “Credit Facility”). Our lenders have notified us that our Credit Facility will terminate on the annual renewal date of May 31, 2006. As a result, we will need a replacement credit facility to meet our capital needs for the remainder of 2006 and beyond.

2




In the absence of receiving a revolving credit facility, management does not believe that our existing capital resources will enable us to fund operations for the next three months. Management plans to obtain alternative financing under a revolving credit facility with new lenders prior to the expiration of our Credit Facility. We did not include any adjustments to the consolidated financial statements included in this Form 10-K to reflect the possible future effects that may result from the uncertainty of our ability to continue as a going concern because we are confident that we will continue to be a financially sound and viable business, providing quality service to our government customers, attractive employment opportunities for our employees and long-term value to our stockholders. We expect to obtain a replacement credit facility in the near future and we believe we are taking the necessary actions to improve our cash flows. We are currently undertaking the following efforts to address this uncertainty:

·       On April 10, 2006 we signed a commitment letter to negotiate a new revolving credit facility with two major money center banks by May 31, 2006, the expiration date of the current Credit Facility;

·       We are working to strengthen the core operating processes of the supply chain and improve productivity;

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

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

·       In the fourth quarter of 2005, we developed a strategic plan to identify and exit failing or non-strategic activities, improve execution of our current business, and emerge as a high-value solutions provider, as described in our Business Strategy section below.

Business Strategy

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

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

Identify and Exit Failing or Non-Strategic Activities

We expect to be more successful by better focusing our many efforts, doing more profitable and strategic activities, and doing fewer activities which are either not profitable or non-strategic. We have reviewed our various activities and eliminated or scaled back poor performing sales teams and are in the process of focusing our marketing and sales efforts on the products, services and vendors which are most profitable. We have reviewed our organization to eliminate duplicative activities and create lines of accountability. The result of these efforts resulted in two reductions in work force: one in October 2005 and a second in February 2006. We continue to measure the performance of various customer teams and lines of business, and adjust our resources to ensure that they are being deployed to maximum advantage.

Improve Execution

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

3




exposed several process inefficiencies throughout GTSI. We believe we can reduce operating costs, improve customer service and improve cash flow through a concerted effort to improve our supply chain and delivery processes. We recently aligned our organization to put all supply-chain and IT activities in one organization to drive the various initiatives to realize the benefits of improved execution. We have begun to map various processes and will be taking additional action intended to improve our current business activities.

Emerge as a High-Value Solutions Provider

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

Focus on the Growing Government IT Market

Because of our historical focus on government, GTSI has developed the expertise and established the vendor and customer relationships necessary to be a leader in this market. As a result, our marketing and sales force are effective at reaching and servicing the government market, which consists of procurement and contracting officers, information resource managers, Chief Information Officers, government IT executives, systems integrators, value-added resellers, prime contractors and a wide array of end-users.

Execute New Government Contracts and Utilize Flexible Contract Vehicles

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

Provide a High-Quality Centralized Source for Procuring IT Products and Services

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

4




Establish and Maintain Strong Vendor Relationships

To provide a centralized source of products and solutions for our customers, GTSI maintains strong relationships with leading hardware, software and services vendors. GTSI offers our vendors a wide range of marketing and sales services, which provide them with access to the millions of end-users constituting the government market. In addition, we insulate our vendors from the procurement regulatory complexities, costs and complicated billing requirements associated with the government market.

Customers

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

 

 

2005

 

2004

 

2003

 

Department of Defense

 

 

35

%

 

 

37

%

 

 

41

%

 

Civilian Agencies and Departments

 

 

42

 

 

 

42

 

 

 

41

 

 

Prime Contractors

 

 

23

 

 

 

21

 

 

 

18

 

 

Total

 

 

100

%

 

 

100

%

 

 

100

%

 

 

Contracts

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

General Services Administration

GTSI holds a GSA designated Schedule 70 contract for the sale of IT products and services. Schedule 70 contracts are multi-award schedule contracts managed by the GSA IT Acquisition Center. In March 2002, the U.S. Federal Government formally exercised its first of three five-year options to extend the GTSI contract through 2007. GSA contracts provide all government agencies, certain international organizations, authorized prime contractors, and state and local governments with an efficient and cost-effective means for buying commercial products. GSA purchasers may place unlimited orders for products under GSA contracts.

5




Our GSA contract contains price reduction clauses requiring that we pass on to government customers certain reduced prices we may receive from our vendors, but prohibits us from passing on price increases for a period of one year. To mitigate the potentially adverse impact of any such price increase, we require substantially all of our vendors who supply our GSA contract to provide us with supply and price protection.

Indefinite Delivery/Indefinite Quantity

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

Details regarding our IDIQ contracts are as follows:

Contract Name

 

 

 

IDIQ Type

 

Contracting Agency

 

Expiration Date

Scientific Engineering Workstation Procurement III (a)

 

GWAC

 

NASA

 

July 30, 2006

Electronic Commodity Store III

 

GWAC

 

NIH (b)

 

Nov. 26, 2012

Maxi-Minis and Databases

 

MAC

 

Army

 

May 25, 2006

Information Technology Enterprise Solutions

 

MAC

 

Army

 

Nov. 1, 2006

Procurement of Computer Hardware and Software-2

 

single agency

 

Veterans Administration

 

April 3, 2007(c)


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

(b)          National Institute of Health

(c)           Contract contains extension options

The products are sold under the contract at a fixed price; however, the government typically negotiates a lower price for large quantity or high value orders.

Blanket Purchase Agreements

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

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

State and Local

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

6




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

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

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

Open Market

We also sell many IT products through open market procurements. These procurements are separate and apart from GSA Schedules, IDIQs and BPAs. Open market procurements include simplified acquisition procedures, requests for quotes, invitations for bids and requests for proposals. GTSI is on most government bid lists relevant to its product offerings and responds with proposals to hundreds of such bid solicitations each year. We also sell to prime contractors to the government, including systems integrators, through open market procurements.

Products, Solutions and Services

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

Hardware

GTSI has strong strategic relationships with global hardware-market leaders. We also have resources dedicated to incubating new vendors as technology develops and emerges. In our traditional reseller capacity, we provide government with products for workgroup computing, such as workstations and desktops; mobility computing and communications, such as wireless-equipped notebooks and PDAs; core computing, such as servers, high-end computing, and storage systems; networking products for LANs, WANs, MANs and personal area networks; and a wide range of peripherals such as disk drives, printers, monitors, scanners, modems and related products. Our core service mix helps customers make the greatest productive use of this technology by assisting them in selecting, configuring, installing and maintaining the components that populate today’s multi-function networks.

Software

We provide software products from most leading desktop and enterprise software providers, including Adobe, BEA Systems, Citrix Systems, Computer Associates, IBM, McAfee, Mercury Interactive, Microsoft Corporation, Red Hat, Symantec/Veritas, and VMWare. GTSI’s stable of software provider relationships is both broad and strong.

7




Solutions

During 2005, we began a realignment of marketing emphasis around a focused number of application areas in which our government customers have consistently demonstrated the greatest immediate strategic interest, and which provide us with the greatest opportunity for sustained return on investment. This emphasis is increasingly revolving around solutions designed to address mission-critical challenges common to many government agencies. Our primary solution attention is being directed toward:

·       IT consolidation, especially for servers and storage systems;

·       Disaster recovery and backup;

·       Mandates for agency migration to next-generation networks, including support for IPv6 and VoIP;

·       E-mail management, especially for archiving, security, infrastructure support, and migration;

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

·       Visual communication support for remote workers and distributed offices, including collaboration, presentation, and broadcast systems.

Each GTSI solution starts with standard components built around a custom deployment model that is determined through our assessment of the customer’s complete application environment. This action plan draws on approaches and technology created across many of our projects to help drive any given project to rapid delivery. It is this combination of core services and approaches that we believe best helps our customers meet their critical budget and deadline requirements.

A typical GTSI solution may draw from any of these core services:

·       Needs analysis and environment assessment;

·       Professional services, including project planning and management, engineering, implementation and training;

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

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

·       Managed fulfillment across multiple products and locations.

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

Services and Warranty

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

8




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

Products

 

 

 

2005

 

2004

 

2003

 

Hardware

 

$

677.7

 

76.5

%

$

834.1

 

77.5

%

$

692.5

 

72.6

%

Software

 

141.6

 

16.0

 

155.7

 

14.5

 

154.5

 

16.2

 

Resold third-party

 

 

 

 

 

 

 

 

 

 

 

 

 

service products

 

48.9

 

5.5

 

66.6

 

6.2

 

91.2

 

9.5

 

Services

 

18.1

 

2.0

 

19.7

 

1.8

 

15.9

 

1.7

 

Total

 

$

886.3

 

100.0

%

$

1,076.1

 

100.0

%

$

954.1

 

100.0

%

 

Vendor Relationships

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

·       Proactive sales of products and solutions;

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

·       Helping to lower costs to comply with procurement regulations involved in selling directly to the government market; and

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

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

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

Inventory Management

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

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

Marketing and Sales

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

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

We recognize that the size and diversity of the government market make it imperative for us to identify and understand the needs of our customers. Through years of intensive effort, GTSI has compiled and maintained a proprietary database that contains an extensive list of agency procurement and contracting officers, information resource managers, senior policy makers, technology influencers, end-users, systems integrators, value added resellers and prime contractors. We use this database to target our marketing efforts and perform data mining for various market research purposes.

Our sales organization is focused on understanding the current and emerging needs of our customers and to provide products, services and bundled solutions to meet those needs. Our sales organization continues to provide deep coverage for existing customers while expanding sales coverage to focus on new accounts and new product and service offerings to current customers.

Competition

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

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

·       Price (for highly commoditized technology);

·       Expertise in government procurement processes (where standardized contracts exist);

·       Existing customer and vendor relationships (for which there is traditionally a high barrier to entry);

·       Technical expertise;

·       Logistical capability; and

·       Customer service and support.

In recent years, competition within the traditional reseller portion of our business has consolidated and intensified. Pricing pressure in particular has been and remains intense. We believe that price competition will continue to increase in 2006, as consolidation continues and competitors rationalize their complete supply chain. This competition may require us in some cases to reduce prices, increase advertising expenditures or undertake other actions to retain our strategic position. Decreasing prices require us to sell a greater number of products to achieve the same level of sales and gross margin. If this trend continues and we are unable to attract new customers and sell increased quantities of products or modify our strategy, our future sales and gross margins may be adversely affected.

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

Backlog

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

Employees

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

Available Information

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

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ITEM 1A.        RISK FACTORS

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

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

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

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

·       Provide a variety of weekly, semi-monthly, and monthly financial reports addressing key aspects of GTSI’s operation including weekly cash flow projections, analyses of aged collections, inventory reports and daily borrowing base certificates;

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

·       Maintain specified total liabilities to tangible net worth ratios;

·       Not exceed the maximum aggregate pre-tax losses on a monthly basis as specified in the Credit Agreement; and

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

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

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

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

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

Infrastructure failures could have a material adverse affect on our business.

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

In April of 2005, GTSI went live with a new supply chain management system based on software provided by Peoplesoft Corporation, the GTSI Enterprise Management System (“GEMS”). Management had planned extensively for this implementation, and had invested a considerable sum of money training associates from a variety of functional disciplines throughout the supply chain.

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

The ongoing use of GEMS involves numerous risks including:

·       difficulties in integrating the system with our current operations;

·       the build-up of excess and obsolete inventory from duplicate orders and higher than usual customer returns;

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

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

·       additional expenses and cash outlays for the maintenance and upkeep of the software;

·       difficulties in obtaining reports to accurately present our external financial results;

·       increased demand on our support operations; and

·       potential delay in the processing of customer orders for shipment of products.

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

We are exposed to inventory risks.

We are exposed to inventory risks as a result of balancing the need to maintain appropriate inventory levels to ensure competitive lead times against the risk of inventory obsolescence because of rapidly changing technology and customer requirements. We seek to minimize our inventory exposure through a

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variety of inventory management procedures and policies, vendor price protection and product return programs. Additionally, more than one-half of our product sales are shipped directly from our vendors to our customers.

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

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

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

We have material weaknesses in our internal control over financial reporting which could have a material adverse effect on our business and a negative impact on our stock price.

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

Although we are currently in the process of implementing remediation measures to correct these material weaknesses, we can provide no assurance that we will be successful in these efforts or that the remediation measures will result in our having adequate internal control over financial reporting in the future. In addition, we cannot assure you that we will not in the future identify further deficiencies or weaknesses in our internal control over financial reporting. If we are unable to adequately remediate our material weaknesses and maintain an effective system of internal control, our ability to timely and accurately report financial results may continue to be adversely affected, which could have a material adverse effect on our ability to operate our business. Any failure to file periodic reports on a timely basis could have many consequences, including: potential delisting from NASDAQ, which would significantly impair the ability of our investors to buy and sell shares; lack of the timely disclosure to the market of our financial results; actions by the SEC against us for failure to comply with applicable Federal securities laws; our inability to use certain short form registration statements; and an event of default under the Credit Agreement with our lenders which would cancel our Credit Facility and cause all outstanding loan

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obligations to become immediately due and payable. In addition, we may incur substantial costs in connection with these remediation measures and the implementation of such measures may distract management from its ordinary business functions.

We will need to hire and successfully integrate additional qualified personnel in our accounting, finance, and operations functions to handle the increased complexity of our business related to the increase in professional services sales and increasingly sophisticated leasing transactions. If we encounter difficulties in attracting or retaining qualified accounting staff, we may not be able to remedy the identified material weakness in our financial close and reporting process. The current employment market for qualified individuals with accounting backgrounds is very competitive, and we may encounter difficulty in identifying, attracting or retaining such individuals. If we are unable to successfully fill our open positions and increase the technical accounting expertise of our accounting function, we may not be able to remedy the identified material weaknesses.

NASDAQ has informed us that our common stock may be delisted, and any such delisting could materially impair the ability of investors to trade in our common stock and could have a material adverse effect on stock price.

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

In addition, our remediation of certain material weaknesses in our internal controls over financial reporting will require extensive time consuming manual processing, which may, in the future, delay completion of our quarterly unaudited consolidated financial statements. This may prevent us from timely filing our reports under the Exchange Act, including our Report on Form 10-Q for the quarter ending March 31, 2006, which would also be a violation of NASDAQ Marketplace Rule 4310(c)(14), and would subject us to potential delisting in the future. If our common stock were to be delisted as a result of our failure to timely file a future quarterly report on Form 10-Q, the ability of our investors to buy and sell shares could be materially impaired which could negatively impact our stock price. The receipt of the staff determination letter from NASDAQ triggered a default under our Credit Agreement.

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

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

During the year ended December 31, 2005 we incurred significant costs due to excess and obsolete inventory, increasing sales returns, significant employee turnover, and the impairment of our deferred tax asset. In addition, costs increased in our accounting department, and are expected to continue in 2006, related to the restatement of prior quarterly results, increased audit fees due to material weaknesses in internal control over financial reporting and the resulting prior period restatements, expansion of the

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

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

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

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

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

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

We rely on U.S. Federal Government agencies and departments to provide a substantial portion of our sales either directly or through prime contractors with which we work. We have derived, and believe that we will continue to derive, a significant portion of our sales from a limited number of projects and transactions with the U.S. Federal Government. For the year ended December 31, 2005, approximately 3% of our largest customer purchase orders represented approximately 80% of our gross margins. The completion or cancellation of a large project or a significant reduction in scope would significantly reduce our gross margins. In addition, if we fail to secure an equal number of large transactions in the future, our results will be negatively impacted.

We have four major contracts that are up for re-compete in 2006. As a result of our recent delivery issues due to the implementation of the final phase of GEMS, we are not certain that we will obtain the re-competed awards. During 2005, these contracts represented approximately 40% of our sales and 35% of our gross margins. Any dispute, failure to exercise an extension, or contract not renewed as a result of a re-compete could have a material adverse impact on our future operating results and gross margins.

Our ability to shift our business model from a reseller of products to a high-end solutions provider has certain risks which may impact future results.

Our goal is to evolve our business from one which resells commodity IT products to one which provides value-added solutions to our government customers. A number of risks are inherent in this strategy. We may not be able to successfully transform our workforce into one which has the technical skills to provide more complex technology to customers. Services and solutions require different internal accounting, tracking, and project management procedures, and there is no assurance we will be able to

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develop and implement those necessary procedures. We will be competing against organizations which have greater experience and past performance in selling solutions to government customers. We will need to secure additional government contracts which provide for us to sell service-only solutions, and those contracts are highly competed. And we will need to develop certain internal technical capabilities to identify, develop, market and sell more complex solutions, and there is no assurance we will be successful in these endeavors.

Compliance with changing regulations of corporate governance and public disclosure may result in additional expenses.

Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and NASDAQ National Market rules, are creating uncertainty for companies such as ours. These new or changed laws, regulations and standards are subject to varying interpretations, in many cases due to their lack of specificity, and as a result their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This could result in higher costs necessitated by ongoing revisions to disclosure and governance practices. As a result, our efforts to comply with evolving laws, regulations and standards have resulted in, and are likely to continue to result in, increased selling, general and administrative expense and a diversion of management’s time and attention from revenue-generating activities to compliance activities. In particular, our efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations regarding our required assessment of internal control over financial reporting and our external auditors’ audit of that assessment require the commitment of significant financial and managerial resources. Further, our Board members, Chief Executive Officer and Chief Financial Officer could face an increased risk of personal liability in connection with the performance of their duties. As a result, we may have difficulty attracting and retaining qualified Board members and executive officers, which could harm our business.

If we are unable to attract and retain talented employees, it could have a material adverse impact on our business and results of operations.

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

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

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

·       The seasonality of our business due to the U.S. Federal Government’s buying and funding patterns;

·       Fluctuations in our gross margins due to variations in the mix of products sold and excess or obsolete inventory charges;

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·       The number, size and scope of orders from our customers;

·       Demand for our services generated by strategic partnerships and certain prime contractors;

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

·       Contractual terms and degree of completion of projects;

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

·       Changes in accounting rules, such as recording expenses for employee stock option grants and tax accounting principles.

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

Because we sometimes work with third parties, any failure by these third parties to satisfactorily perform their obligations could hurt our reputation, operating results and competitiveness.

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

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

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

·       our performance on individual contracts and delivery orders;

·       the strength of our professional reputation;

·       the relationships of our key executives with customer personnel; and

·       our compliance with complex procurement laws and regulations related to the formation, administration and performance of U.S. Federal Government contracts.

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

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

Our markets are highly competitive; if we do not compete effectively, we could face continued operating losses and loss of market share.

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

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

·       Expertise in government procurement processes where standardized contracts exist;

·       Existing customer and vendor relationships (for which there is traditionally a high barrier to entry);

·       Technical expertise;

·       Logistical capability;

·       the ability of our clients or competitors to hire and retain project managers and other senior technical staff;

·       the price at which others offer comparable technical solutions; and

·       the extent of our competitors’ responsiveness to client needs.

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

We may not qualify as a small business for new contract awards.

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

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

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

Adverse changes in U.S. Federal Government fiscal spending could have a negative effect on our sales, gross margin, and cash flow.

Changes in U.S. Federal Government spending policies or budget priorities could directly affect our financial performance. Among the factors that could materially harm our business are:

·       a significant decline in spending by the U.S. Federal Government in general or by specific departments or agencies in particular;

·       changes in the structure, composition and/or buying patterns of the U.S. Federal Government;

·       the adoption of new laws or regulations changing procurement practices; or

·       delays in the payment of our invoices by government payment offices.

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

Any potential future acquisitions, strategic investments or mergers may subject us to significant risks, any of which could harm our business.

Our long-term strategy may include identifying and acquiring, investing in or merging with suitable candidates on acceptable terms. In particular, over time, we may acquire, make investments in, or merge with providers of product offerings that complement our business. Acquisitions include a number of risks and present financial, managerial and operational challenges, including:

·       diversion of management attention from running our existing business;

·       possible additional material weaknesses in internal control over financial reporting;

·       increased expenses including legal, administrative and compensation expenses related to newly hired employees;

·       increased costs to integrate the technology, personnel, customer base and business practices of the acquired company with our own;

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

·       potential adverse effects on our reported operating results due to possible write-down of goodwill and other intangible assets associated with acquisitions; and

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

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

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

ITEM 1B.       UNRESOLVED STAFF COMMENTS

Not applicable.

ITEM 2.                PROPERTIES

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

As a result of our workforce realignment activities taken in 2006, we currently have facilities in excess of our needs. In 2006 we plan to consolidate our office locations and sublease one facility. We believe the facilities we are retaining are in good condition and suitable to meet our current needs for the conduct of our business. For additional information regarding our obligations under leases, see Note 13 of the consolidated financial statements in Part II, Item 8 of this Form 10-K.

ITEM 3.                LEGAL PROCEEDINGS

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

ITEM 4.                SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

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

21




PART II

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

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

Price Range of Common Stock

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

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

Quarter

 

 

 

2005

 

2004

 

First

 

$

11.13

 

$

9.46

 

$

14.52

 

$

11.39

 

Second

 

$

10.10

 

$

7.80

 

$

12.63

 

$

10.10

 

Third

 

$

8.49

 

$

6.75

 

$

11.54

 

$

7.86

 

Fourth

 

$

8.80

 

$

7.00

 

$

11.12

 

$

8.44

 

 

GTSI’s transfer agent is American Stock Transfer & Trust Company, 59 Maiden Lane, New York, NY 10038; telephone 1-866-668-6550.

Dividends

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

Issuer Purchases of Equity Securities

GTSI made the following purchases of its common stock during the fourth quarter of 2005:

Period

 

 

 

Total
Number of
Shares
Purchased

 

Average
Price Paid
per Share

 

Total
Number of
Shares
Purchased as
Part of Publicly
Announced
Program

 

Approximate
Dollar Value 
of Shares that
May Yet Be
Purchased
Under the
Program

 

October 1 to October 31, 2005

 

 

99,800

 

 

 

$

7.52

 

 

 

99,800

 

 

 

 

 

 

November 1 to November 30, 2005

 

 

79,600

 

 

 

$

8.21

 

 

 

79,600

 

 

 

 

 

 

December 1 to December 31, 2005

 

 

56,400

 

 

 

$

8.50

 

 

 

56,400

 

 

 

 

 

 

Total—Three Months Ended December 31, 2005

 

 

235,800

 

 

 

$

7.99

 

 

 

235,800

 

 

 

$

5,126,176

 

 

 

22




GTSI’s common stock purchase program was announced in February 2000. GTSI’s Board of Directors authorized GTSI to repurchase its common stock for an aggregate purchase price up to $5.25 million. In January 2002 and April 2005, GTSI’s Board of Directors authorized additional purchases to increase the aggregate purchase amount to $10 million. This purchase program, as increased, is the only stock purchase program currently in effect and there have been no repurchase programs that have expired during the period covered by this report.

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

Equity Compensation Plans

The following table summarizes information regarding GTSI’s equity compensation plans as of December 31, 2005.

Plan Category

 

 

 

Number of Shares
to be Issued upon 
Exercise of 
Outstanding
Options
(a)

 

Weighted Average
Exercise Price
of Outstanding 
Options
(b)

 

Number of Shares
Remaining Available 
for Future Issuance
Under Equity
Compensation Plans
(excluding shares
reflected in column (a))
(c)

 

Equity compensation plans approved by stockholders

 

 

1,825,350

 

 

 

$

8.3615

 

 

 

675,252

 

 

Equity compensation plans not approved by stockholders*

 

 

263,000

 

 

 

$

9.9930

 

 

 

N/A

 

 

Total

 

 

2,088,350

 

 

 

$

8.5670

 

 

 

675,252

 

 


*                    Represents shares issuable under options granted from time to time to persons not previously employed by the Company, as an inducement essential to such persons entering into employment agreements with the Company.

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

ITEM 6.                SELECTED FINANCIAL DATA

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

23




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

Statement of Operations Data:

 

 

For the years ended December 31,

 

 

 

2005

 

2004

 

2003

 

2002

 

2001

 

 

 

(in thousands, except per share data)

 

Sales

 

$

886,263

 

$

1,076,148

 

$

954,118

 

$

934,730

 

$

783,496

 

Cost of sales

 

791,346

 

954,143

 

857,334

 

857,105

 

718,370

 

Gross margin

 

94,917

 

122,005

 

96,784

 

77,625

 

65,126

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

115,201

 

107,833

 

85,473

 

62,956

 

57,002

 

Depreciation and amortization

 

4,250

 

3,022

 

2,874

 

3,543

 

4,407

 

Impairment charge

 

981

 

 

5,972

 

 

 

Total operating expenses

 

120,432

 

110,855

 

94,319

 

66,499

 

61,409

 

(Loss) income from operations

 

(25,515

)

11,150

 

2,465

 

11,126

 

3,717

 

Interest and other income, net

 

6,729

 

5,569

 

2,832

 

4,520

 

3,707

 

(Loss) income before income taxes

 

(18,786

)

16,719

 

5,297

 

15,646

 

7,424

 

Income tax benefit (provision)

 

2,787

 

(6,455

)

(2,118

)

(6,113

)

(2,938

)

Net (loss) income

 

$

(15,999

)

$

10,264

 

$

3,179

 

$

9,533

 

$

4,486

 

(Loss) earnings per common share

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

(1.74

)

$

1.18

 

$

0.38

 

$

1.15

 

$

0.55

 

Diluted

 

$

(1.74

)

$

1.09

 

$

0.35

 

$

1.04

 

$

0.50

 

Weighted average common shares outstanding

 

 

 

 

 

 

 

 

 

 

 

Basic

 

9,177

 

8,664

 

8,349

 

8,302

 

8,144

 

Diluted

 

9,177

 

9,388

 

9,116

 

9,156

 

9,049

 

 

Balance Sheet Data:

 

 

As of December 31,

 

 

 

2005

 

2004

 

2003

 

2002

 

2001

 

 

 

(in thousands)

 

Working capital

 

$

60,560

 

$

79,027

 

$

64,348

 

$

62,836

 

$

34,968

 

Total assets

 

$

306,657

 

$

296,386

 

$

268,761

 

$

224,918

 

$

252,452

 

Borrowings under credit facility

 

$

48,014

 

$

1,179

 

$

12,813

 

$

7,539

 

$

20,186

 

Long-term liabilities

 

$

3,922

 

$

3,473

 

$

1,522

 

$

1,640

 

$

2,403

 

Total liabilities

 

$

231,963

 

$

204,249

 

$

190,816

 

$

149,427

 

$

189,387

 

Stockholders’ equity

 

$

74,694

 

$

92,137

 

$

77,945

 

$

75,491

 

$

63,065

 

 

24




ITEM 7.                MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

Restatement

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

Going Concern

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

In the absence of receiving a credit facility, management does not believe that our existing capital resources will enable us to fund operations for the next three months. Management plans to obtain alternative financing under a revolving credit facility with new lenders prior to the expiration of our Credit Facility. We did not include any adjustments to the consolidated financial statements included in this Form 10-K to reflect the possible future effects that may result from the uncertainty of our ability to continue as a going concern because we are confident that we will continue to be a financially sound and viable business, providing quality service to our government customers, attractive employment opportunities for our employees and long-term value to our stockholders. We expect to obtain a replacement credit facility in the near future and we are taking the necessary actions to improve our cash flows. We are currently undertaking the following efforts to address this uncertainty:

·       On April 10, 2006 we signed a commitment letter to negotiate a new revolving credit facility with two major money center banks by May 31, 2006, the expiration date of the current Credit Facility;

·       We are working to strengthen the core operating processes of the supply chain and improve productivity;

·       We have concerted efforts underway to improve working capital by collected aged receivables, increase the amount of partial billings and invoice customers as soon as allowed; and

25




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

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

Overview

GTSI has more than 20 years of experience in selling IT products and solutions primarily to U.S. Federal Government customers. We believe our key differentiators to be our strong brand among government customers, extensive contract portfolio and wide variety of vendors.

The vast majority of the IT solutions we offer to our customers have a strong product component, and many are entirely product-based. We connect IT’s leading vendors, products and services inside the core technology areas most critical to government success by partnering with global IT leaders such as Panasonic, HP, Cisco, Sun Microsystems and Microsoft. In our traditional reseller capacity, we provide government with products for workgroup computing, such as workstations and desktops; mobility computing and communications, such as wireless-equipped notebooks and PDAs; core computing, such as servers, high-end computing, and storage systems; networking products; and a wide range of peripherals.

During 2005, we began focusing on application areas in which our government customers have consistently demonstrated the greatest immediate strategic interest, and which provide us with the greatest opportunity for sustained return on investment. Our primary solution attention is being directed toward IT consolidation, disaster recovery and backup, e-mail management, and visual communication support for remote workers and distributed offices, including collaboration, presentation, and broadcast systems.

To help our customers acquire, manage and refresh this technology in a strategic and application-appropriate manner, GTSI has created a mix of financial services capable of managing the entire technology lifecycle. GTSI offers leasing arrangements to allow government agencies to acquire access to technology as an evenly distributed operating expense, rather than the much more budget-sensitive and discontinuous capital expenses. This model is in high demand from our customers, and we believe it represents a distinctive advantage. We expect to continue to expand our sales from leasing arrangements for IT products and solutions in 2006.

In April of 2005, GTSI went live with a new supply chain management system based on software provided by Peoplesoft Corporation, the GTSI Enterprise Management System (“GEMS”). Management had planned extensively for this implementation, and had invested a considerable sum of money training associates from a variety of functional disciplines throughout the supply chain.

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

As discussed in more detail in our MD&A:

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

26




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

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

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

·       Cash used in operations totaled approximately $42 million;

·       We recorded prior period adjustments to our previously issued 2005 quarterly financial statements; however,

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

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

Critical Accounting Estimates and Policies

The discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires management to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results may differ from these estimates under different assumptions or conditions. Critical accounting estimates are defined as those that are reflective of significant judgments and uncertainties, and potentially result in materially different results under different assumptions and conditions. We have included below our policies that are both important to our financial condition and operating results, and require management’s most subjective and complex judgments in determining the underlying estimates and assumptions.

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

Revenue Recognition

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

27




of reporting periods to estimate the amount of products in transit to the customer that cannot be recognized as revenue. Many of our sales of physical products are shipped to our customers directly from our vendor partners. The accurate recording of revenue for these transactions relies upon the accuracy of shipment dates we receive from our vendors and is subject to additional estimates and judgments by management.

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

Certain of our service and solution agreements require significant revenue recognition estimates including progress towards completion and total estimated costs to complete. Revenues on professional service contracts are generally recognized using the proportional-performance basis of accounting. For some professional services engagements, services to be performed in the last series of acts is so significant in relation to the entire service contract that performance is deemed not to have occurred until the final act is completed, or there are customer-specified subjective acceptance criteria; the completed-performance method is used.

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

Inventory

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

During 2005, due to the difficulties arising from the implementation of GEMS including ordering excess inventory and distraction of personnel from the management of procurement and inventory, we recorded an impairment charge of $5.6 million for obsolete and excess inventory, which reduced our Gross Margin by the same amount. During 2004 as a result of our physical inventory counts and other internal controls, we discovered two instances of inventory losses which resulted in a charge to Cost of Sales of $0.7 million, net of insurance settlement.

Capitalized Internal Use Software

Significant judgment is required to determine what expenditures qualify for capitalization of internal use software. Subsequent additions, modifications or upgrades to internal-use software are capitalized only to the extent that they allow the software to perform a task that it previously did not perform. Capitalized internal use software is required to be tested for recoverability whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. If the carrying value exceeds the undiscounted cash flows expected to result from the use and eventual disposition of the asset, an impairment charge is recognized.

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

28




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

Accounts Payable

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

Income Taxes

Determining our effective tax rate, provision for tax expense, deferred tax assets and liabilities and the related valuation allowance involves judgments and estimates. Deferred income taxes result from temporary differences between the tax basis of assets and liabilities and the basis reported in our consolidated financial statements. Deferred tax liabilities and assets are determined based on the difference between financial statement and tax basis of assets and liabilities using enacted rates expected to be in effect during the year in which the differences reverse. Valuation allowances are provided against assets, including net operating losses, if it is anticipated that the asset is not more likely than not to be realized through future taxable earnings or implementation of tax planning strategies. We record reserves for uncertain tax positions, which management believes are adequate. We recorded a valuation allowance during 2005 against the full amount of our net deferred tax assets, because in the opinion of management, it is more likely than not that these deferred tax assets will not be realized. Our effective tax rate in a given period could be impacted if we determine the allowance is or is not required, or if we were required to pay amounts in excess of established reserves. See Note 11 to the consolidated financial statements.

29




Historical Results of Operations

The following table illustrates the percentage of sales represented by items in our consolidated statements of operations for the years ended December 31:

 

 

2005

 

2004

 

2003

 

Sales

 

100.0

%

100.0

%

100.0

%

Cost of sales

 

89.3

 

88.7

 

89.9

 

Gross margin

 

10.7

 

11.3

 

10.1

 

Operating expenses:

 

 

 

 

 

 

 

Selling, general and administrative

 

13.0

 

10.0

 

8.9

 

Depreciation and amortization

 

0.5

 

0.3

 

0.3

 

Impairment charge

 

0.1

 

-

 

0.6

 

Total operating expenses

 

13.6

 

10.3

 

9.8

 

(Loss) income from operations

 

(2.9

)

1.0

 

0.3

 

Interest and other income, net

 

0.8

 

0.6

 

0.3

 

(Loss) income before taxes

 

(2.1

)

1.6

 

0.6

 

Income tax benefit (provision)

 

0.3

 

(0.6

)

(0.3

)

Net (loss) income

 

(1.8

)%

1.0

%

0.3

%

 

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

Sales by Vendor

 

2005

 

2004

 

2003

 

Panasonic

 

$

179.7

 

20.3

%

$

188.0

 

17.5

%

$

162.2

 

17.0

%

HP

 

84.1

 

9.5

 

153.4

 

14.3

 

139.3

 

14.6

 

Cisco

 

115.1

 

13.0

 

135.7

 

12.6

 

112.9

 

11.8

 

Sun Microsystems

 

111.6

 

12.6

 

131.8

 

12.2

 

130.1

 

13.6

 

Microsoft

 

31.0

 

3.5

 

53.7

 

5.0

 

66.5

 

7.0

 

Others, net of reserves

 

364.8

 

41.1

 

413.5

 

38.4

 

343.1

 

36.0

 

Total

 

$

886.3

 

100.0

%

$

1,076.1

 

100.0

%

$

954.1

 

100.0

%

 

Sale by Type

 

2005

 

2004

 

2003

 

Hardware, net of reserves

 

$

677.7

 

76.5

%

$

834.1

 

77.5

%

$

692.5

 

72.6

%

Software

 

141.6

 

16.0

 

155.7

 

14.5

 

154.5

 

16.2

 

Resold third-party service products

 

48.9

 

5.5

 

66.6

 

6.2

 

91.2

 

9.5

 

Services

 

18.1

 

2.0

 

19.7

 

1.8

 

15.9

 

1.7

 

Total

 

$

886.3

 

100.0

%

$

1,076.1

 

100.0

%

$

954.1

 

100.0

%

 

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

Sales

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

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

30




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

GTSI will be required to recertify our “small business” size status on our GSA Schedule Contract no later than 2007. At such time, we may not qualify as a small business. To mitigate any potential adverse affect on our sales from the loss of our small business status, GTSI has developed strategic relationships with small businesses that benefit from the small business benefits described in the Business section in Part I of this Form 10-K. GTSI acts as both a supplier and prime contractor to these small businesses. In addition, we further mitigate this risk by participating in the Mentor-Protégé Program offered under the SBAs 8(a) program, which is a business development initiative that helps socially and economically disadvantaged Americans gain access to economic opportunity.

Gross Margin

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

Selling, General & Administrative Expenses

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

Impairment Charge

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

Interest and Other Income, Net

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

Income Taxes

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

31




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

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

Sales

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

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

Gross Margin

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

Selling, General & Administrative Expenses

SG&A expenses for 2004 increased $22.5 million, or 25.5% from 2003. This increase was primarily related to approximately $6.9 million in compensation and benefits expense from the company-wide headcount increase and $6.1 million of additional commissions and commission accelerators paid on our increased sales.

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

Impairment Charge

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

32




Interest and Other Income, Net

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

Income Taxes

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

Seasonal Fluctuations

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

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

 

 

2005

 

 

 

Q1
(restated)

 

Q2
(restated)

 

Q3
(restated)

 

Q4

 

Total

 

 

 

(in millions except per share data)

 

Sales

 

 

$

160.7

 

 

 

$

176.5

 

 

 

$

269.9

 

 

$

279.2

 

$

886.3

 

Cost of sales

 

 

142.2

 

 

 

160.6

 

 

 

237.8

 

 

250.8

 

791.4

 

Gross margin

 

 

18.5

 

 

 

15.9

 

 

 

32.1

 

 

28.4

 

94.9

 

SG&A expenses

 

 

28.3

 

 

 

28.4

 

 

 

31.9

 

 

31.8

 

120.4

 

(Loss) income from operations

 

 

(9.8

)

 

 

(12.5

)

 

 

0.2

 

 

(3.4

)

(25.5

)

Interest and other income, net

 

 

0.7

 

 

 

0.4

 

 

 

4.3

 

 

1.4

 

6.7

 

(Loss) income before taxes

 

 

(9.1

)

 

 

(12.1

)

 

 

4.5

 

 

(2.0

)

(18.8

)

Income tax benefit (provision)

 

 

3.6

 

 

 

4.4

 

 

 

(1.6

)

 

(3.6

)

2.8

 

Net (loss) income

 

 

$

(5.5

)

 

 

$

(7.7

)

 

 

$

2.9

 

 

$

(5.6

)

$

(16.0

)

Basic (loss) earnings per share

 

 

$

(0.61

)

 

 

$

(0.84

)

 

 

$

0.31

 

 

$

(0.61

)

$

(1.74

)

Diluted (loss) earnings per share

 

 

$

(0.61

)

 

 

$

(0.84

)

 

 

$

0.30

 

 

$

(0.61

)

$

(1.74

)

 

33




 

 

 

2004

 

 

 

Q1

 

Q2

 

Q3

 

Q4

 

Total

 

 

 

(in millions except per share data)

 

Sales

 

 

$

178.6

 

 

 

$

239.0

 

 

 

$

330.6

 

 

$

327.9

 

$

1,076.1

 

Cost of sales

 

 

160.5

 

 

 

217.5

 

 

 

283.9

 

 

292.2

 

954.1

 

Gross margin

 

 

18.1

 

 

 

21.5

 

 

 

46.7

 

 

35.7

 

122.0

 

SG&A expenses

 

 

21.7

 

 

 

24.6

 

 

 

30.4

 

 

34.2

 

110.9

 

(Loss) income from operations

 

 

(3.6

)

 

 

(3.1

)

 

 

16.3

 

 

1.5

 

11.1

 

Interest and other income, net

 

 

1.3

 

 

 

0.5

 

 

 

1.0

 

 

2.8

 

5.6

 

(Loss) income before taxes

 

 

(2.3

)

 

 

(2.6

)

 

 

17.3

 

 

4.3

 

16.7

 

Income tax benefit (provision)

 

 

0.9

 

 

 

1.0

 

 

 

(6.8

)

 

(1.5

)

(6.4

)

Net (loss) income

 

 

$

(1.4

)

 

 

$

(1.6

)

 

 

$

10.5

 

 

$

2.8

 

$

10.3

 

Basic (loss) earnings per share

 

 

$

(0.16

)

 

 

$

(0.18

)

 

 

$

1.21

 

 

$

0.31

 

$

1.18

 

Diluted (loss) earnings per share

 

 

$

(0.16

)

 

 

$

(0.18

)

 

 

$

1.13

 

 

$

0.29

 

$

1.09

 

 

Liquidity and Capital Resources

Cash flows for the year ended December 31,

 

 

2005

 

2004

 

Increase/
(Decrease)

 

 

 

(in millions)

 

Cash (used in) provided by operating activities

 

$

(42.0

)

$

16.8

 

 

$

58.8

 

 

Cash used in investing activities

 

$

(3.7

)

$

(7.5

)

 

$

(3.8

)

 

Cash provided by (used in) financing activities

 

$

45.3

 

$

(9.1

)

 

$

54.4

 

 

 

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

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

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

Credit Facility

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

34




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

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

At December 31, 2005 and 2004, our interest rate under the Credit Facility was 6.1% and 4.2%, respectively. The weighted average interest rates for the years ended December 31, 2005, 2004 and 2003 were 5.1%, 3.2% and 3.0%, respectively.

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

Capital Resources and Requirements

Our ongoing capital requirements depend on a variety of factors, including the extent to which we are able to fund the cash needs of our business from operations. During 2005, we experienced significant working capital shortages as a result of our operational problems and lower sales volumes, and relied upon vendor credit and borrowings under our Credit Facility to fund our operations. We anticipate that we will continue to rely primarily on vendor credit and a replacement credit facility to finance our operating cash needs during the majority of 2006. We believe that such funds should be sufficient to satisfy our near term anticipated cash requirements for operations, assuming we are successful at structuring a new revolving credit facility prior to the expiration of our existing Credit Facility on May 31, 2006. We continue to have discussions with lenders related to structuring a new revolving credit facility and on April 10, 2006 we signed a commitment letter to negotiate a new revolving credit facility with two major money center banks by May 31, 2006, the expiration date of the current Credit Facility.  Nonetheless, we may seek additional sources of capital, including obtaining permanent financing over a longer term at fixed rates, to finance our working capital requirements or other strategic initiatives. If we are unable to obtain alternative financing it would likely have a material adverse affect on our financial condition and ability to continue as a going concern.

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

35




Contractual Obligations

(in millions)

 

Total

 

Less Than
1 Year

 

1-3
Years

 

3-5
Years

 

Operating Lease Obligations

 

$

11.4

 

 

$

2.9

 

 

 

$

6.9

 

 

 

$

1.6

 

 

Borrowings under Credit Facility

 

48.0

 

 

48.0

 

 

 

 

 

 

 

 

Total Contractual Obligations

 

$

59.4

 

 

$

50.9

 

 

 

$

6.9

 

 

 

$

1.6

 

 

 

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

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

Off-Balance Sheet Arrangements

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

New Accounting Pronouncements

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

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

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

36




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

ITEM 7A.        QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

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

37




ITEM 8.

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

To the Board of Directors and Stockholders of GTSI Corp.

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

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

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

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

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of GTSI Corp.’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated April 10, 2006 expressed an unqualified opinion on management’s assessment and an adverse opinion on the effectiveness of the Company’s internal control over financial reporting because of the existence of certain material weaknesses.

/s/ ERNST & YOUNG LLP

 

McLean, Virginia
April 10, 2006

38




FINANCIAL STATEMENT AND SUPPLEMENTARY DATA
GTSI CORP.
CONSOLIDATED BALANCE SHEETS

 

 

December 31,

 

 

 

2005

 

2004

 

 

 

(In thousands, except
share and per share data)

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash

 

$

22

 

$

397

 

Accounts receivable, net

 

207,886

 

204,842

 

Inventory

 

56,666

 

59,184

 

Deferred costs

 

14,909

 

4,218

 

Other current assets

 

9,118

 

11,162

 

Total current assets

 

288,601

 

279,803

 

Depreciable assets, net

 

13,640

 

15,183

 

Other assets

 

4,416

 

1,400

 

Total assets

 

$

306,657

 

$

296,386

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Borrowings under credit facility

 

$

48,014

 

$

1,179

 

Accounts payable

 

159,038

 

173,218

 

Accrued liabilities

 

16,634

 

14,734

 

Deferred revenue

 

3,611

 

9,216

 

Accrued warranty liabilities

 

744

 

2,429

 

Total current liabilities

 

228,041

 

200,776

 

Other liabilities

 

3,922

 

3,473

 

Total liabilities

 

231,963

 

204,249

 

Commitments and contingencies—See Note 13

 

 

 

 

 

Stockholders’ equity

 

 

 

 

 

Preferred stock - $0.25 par value, 680,850 shares authorized; none issued or outstanding

 

 

 

Common stock - $0.005 par value, 20,000,000 shares authorized; 9,806,084 issued and 9,442,887 outstanding at December 31, 2005; and 9,806,084 issued and 8,987,643 outstanding at December 31, 2004

 

49

 

49

 

Capital in excess of par value

 

42,943

 

46,817

 

Retained earnings

 

34,396

 

50,395

 

Treasury stock, 361,530 shares at December 31, 2005and 818,441 shares at December 31, 2004, at cost

 

(2,694

)

(5,124

)

Total stockholders’ equity

 

74,694

 

92,137

 

Total liabilities and stockholders’ equity

 

$

306,657

 

$

296,386

 

 

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

39




GTSI CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

For the Years Ended December 31,

 

 

 

2005

 

2004

 

2003

 

 

 

(In thousands, except share and per share data)

 

SALES

 

$

886,263

 

$

1,076,148

 

$

954,118

 

COST OF SALES

 

791,346

 

954,143

 

857,334

 

GROSS MARGIN

 

94,917

 

122,005

 

96,784

 

SELLING, GENERAL & ADMINISTRATIVE EXPENSES

 

119,451

 

110,855

 

88,347

 

IMPAIRMENT CHARGE

 

981

 

 

5,972

 

TOTAL OPERATING EXPENSES

 

120,432

 

110,855

 

94,319

 

(LOSS) INCOME FROM OPERATIONS

 

(25,515

)

11,150

 

2,465

 

INTEREST AND OTHER INCOME

 

 

 

 

 

 

 

Lease-related income

 

5,934

 

3,745

 

526

 

Interest and other income

 

1,779

 

2,135

 

2,593

 

Interest expense

 

(984

)

(311

)

(287

)

Interest and other income, net

 

6,729

 

5,569

 

2,832

 

(LOSS) INCOME BEFORE INCOME TAXES

 

(18,786

)

16,719

 

5,297

 

INCOME TAX BENEFIT (PROVISION)

 

2,787

 

(6,455

)

(2,118

)

NET (LOSS) INCOME

 

$

(15,999

)

$

10,264

 

$

3,179

 

(LOSS) EARNINGS PER SHARE

 

 

 

 

 

 

 

Basic

 

$

(1.74

)

$

1.18

 

$

0.38

 

Diluted

 

$

(1.74

)

$

1.09

 

$

0.35

 

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING

 

 

 

 

 

 

 

Basic

 

9,177

 

8,664

 

8,349

 

Diluted

 

9,177

 

9,388

 

9,116

 

 

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

40




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

 

 

Common Stock

 

Capital in

 

 

 

 

 

Total

 

 

 

Shares
Outstanding

 

Amount

 

Excess of
Par Value

 

Retained
Earnings

 

Treasury
Stock

 

Stockholders’
Equity

 

 

 

(In thousands)

 

Balance, December 31, 2002

 

 

8,610

 

 

 

$

49

 

 

 

$

44,439

 

 

$

36,952

 

$

(5,949

)

 

$

75,491

 

 

Stock options exercised

 

 

355

 

 

 

 

 

 

155

 

 

 

882

 

 

1,037

 

 

Employee stock purchase plan

 

 

147

 

 

 

 

 

 

203

 

 

 

891

 

 

1,094

 

 

Common stock purchase

 

 

(607

)

 

 

 

 

 

 

 

 

(3,970

)

 

(3,970

)

 

Tax benefit of stock options exercised

 

 

 

 

 

 

 

 

1,114

 

 

 

 

 

1,114

 

 

Net income

 

 

 

 

 

 

 

 

 

 

3,179

 

 

 

3,179

 

 

Balance, December 31, 2003

 

 

8,505

 

 

 

49

 

 

 

45,911

 

 

40,131

 

(8,146

)

 

77,945

 

 

Stock options exercised

 

 

398

 

 

 

 

 

 

(713

)

 

 

2,489

 

 

1,776

 

 

Employee stock purchase plan

 

 

85

 

 

 

 

 

 

262

 

 

 

533

 

 

795

 

 

Stock based compensation

 

 

 

 

 

 

 

 

480

 

 

 

 

 

480

 

 

Tax benefit of stock options exercised

 

 

 

 

 

 

 

 

877

 

 

 

 

 

877

 

 

Net income

 

 

 

 

 

 

 

 

 

 

10,264

 

 

 

10,264

 

 

Balance, December 31, 2004

 

 

8,988

 

 

 

49

 

 

 

46,817

 

 

50,395

 

(5,124

)

 

92,137

 

 

Stock options exercised

 

 

938

 

 

 

 

 

 

(3,854

)

 

 

6,731

 

 

2,877

 

 

Employee stock purchase plan

 

 

77

 

 

 

 

 

 

(78

)

 

 

572

 

 

494

 

 

Common stock purchase