10-Q 1 gtsi_10q.txt FORM 10-Q ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004 Commission File No. 0-19394 GTSI CORP. (Exact name of registrant as specified in its charter) Delaware 54-1248422 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 3901 Stonecroft Boulevard Chantilly, VA 20151-1010 (Address and zip code of principal executive offices) 703-502-2000 (Registrant's telephone number, including area code) 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 [X] NO [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: Class Shares Outstanding at April 30, 2004 ------------------------------------ -------------------------------------- Common Stock, $0.005 par value 8,571,837 ================================================================================ GTSI CORP. AND SUBSIDIARY Quarterly Report on Form 10-Q for the Period Ended March 31, 2004
Table of Contents Page ----------------- ---- COVER PAGE..................................................................................1 TABLE OF CONTENTS...........................................................................2 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS - Consolidated Balance Sheets as of March 31, 2004 (Unaudited) and December 31, 2003......................3 Consolidated Statements of Operations for the Three Months Ended March 31, 2004 and 2003 (Unaudited)................4 Consolidated Condensed Statements of Cash Flows for the Three Months Ended March 31, 2004 and 2003 (Unaudited)................5 Notes to Unaudited Consolidated Condensed Financial Statements............6 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS..................................10 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK...............17 ITEM 4. CONTROLS AND PROCEDURES..................................................17 PART II - OTHER INFORMATION................................................................17 ITEM 1. LEGAL PROCEDURES ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K SIGNATURES.................................................................................18
- 2 - GTSI CORP. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share data)
March 31, December 31, 2004 2003 --------- ------------ (Unaudited) (Audited) ASSETS Current assets: Cash $ 21,563 $ 177 Accounts receivable, net 126,282 180,270 Lease receivables, current 2,790 1,718 Merchandise inventories 57,053 55,987 Other current assets 13,842 15,490 --------- --------- Total current assets 221,530 253,642 Property and equipment, net 11,868 10,670 Other assets 2,063 4,449 --------- --------- Total assets $ 235,461 $ 268,761 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Notes payable to banks $ -- $ 12,813 Accounts payable 133,299 152,435 Accrued liabilities 11,138 11,168 Deferred revenue 7,994 8,323 Accrued warranty liabilities 4,495 4,555 --------- --------- Total current liabilities 156,926 189,294 Other liabilities 1,415 1,522 --------- --------- Total liabilities 158,341 190,816 --------- --------- Commitments and contingencies 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 8,569,087 outstanding at March 31, 2004; and 20,000,000 shares authorized; 9,806,084 issued and 8,505,045 outstanding at December 31, 2003 49 49 Capital in excess of par value 46,065 45,911 Retained earnings 38,750 40,131 Treasury stock, 1,236,997 shares at March 31, 2004 and 1,301,039 shares at December 31, 2003, at cost (7,744) (8,146) --------- --------- Total stockholders' equity 77,120 77,945 --------- --------- Total liabilities and stockholders' equity $ 235,461 $ 268,761 ========= =========
The accompanying notes are an integral part of these consolidated financial statements. - 3 - GTSI CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except share and per share data) (Unaudited) Three months ended March 31, 2004 2003 --------- --------- Sales $ 178,623 $ 178,858 Cost of sales 160,541 162,784 --------- --------- Gross margin 18,082 16,074 Operating expenses 21,697 19,702 --------- --------- Loss from operations (3,615) (3,628) --------- --------- Interest and other income 1,370 781 Interest expense (37) (48) --------- --------- Interest and other income, net 1,333 733 --------- --------- Loss before income taxes (2,282) (2,895) Income tax benefit (901) (1,132) --------- --------- Net loss $ (1,381) $ (1,763) ========= ========= Basic net loss per share $ (0.16) $ (0.21) ========= ========= Diluted net loss per share $ (0.16) $ (0.21) ========= ========= Basic weighted average shares outstanding 8,556 8,564 ========= ========= Diluted weighted average shares outstanding 8,556 8,564 ========= ========= The accompanying notes are an integral part of these consolidated financial statements. - 4 - GTSI CORP. AND SUBSIDIARY CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited) Three months ended March 31, 2004 2003 -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $ (1,381) $ (1,763) Adjustments to reconcile net loss to net cash provided by operating activities 36,926 18,654 -------- -------- Net cash provided by operating activities 35,545 16,891 -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment (1,901) (2,242) -------- -------- Net cash used in investing activities (1,901) (2,242) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Payments of bank notes, net (12,813) (7,539) Common stock repurchase -- (1,773) Proceeds from exercises of stock options 555 307 -------- -------- Net cash used in financing activities (12,258) (9,005) -------- -------- Net increase in cash 21,386 5,644 Cash at beginning of period 177 32 -------- -------- Cash at end of period $ 21,563 $ 5,676 ======== ======== Supplemental disclosures of cash flow information: Cash paid during the three months for: Interest $ 21 $ 82 ======== ======== Income taxes $ 1,018 $ -- ======== ======== The accompanying notes are an integral part of these consolidated financial statements. - 5 - GTSI CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Unaudited) 1. Basis of Presentation The accompanying unaudited consolidated financial statements of GTSI Corp. ("GTSI" or the "Company") have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC") and, therefore, omit or condense certain footnotes and other information normally included in financial statements prepared in accordance with generally accepted accounting principles. This report should be read in conjunction with the audited financial statements for the year ended December 31, 2003 and the accompanying Notes to the Financial Statements, contained in the Company's 2003 Annual Report on Form 10-K. In the opinion of Management, all adjustments, consisting primarily of normal recurring adjustments, necessary for a fair presentation of interim period results have been included. The results of operations for the three month period ended March 31, 2004 are not necessarily indicative of the results that may be expected for the full year, or future periods. New Accounting Pronouncements In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46, "Consolidation of Variable Interest Entities (FIN No. 46). FIN No. 46 clarifies the application of Accounting Research Bulletin No. 51, "Consolidated Financial Statements" to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from the other parties. FIN No. 46 applies to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after December 15, 2003, which is the Company's first quarter of fiscal year 2004. The Company has adopted FIN No. 46 with no material impact on its condensed consolidated financial statements. 2. Consolidation The consolidated financial statements include the accounts of the Company and its wholly owned subsidiary. Material intercompany transactions and balances have been eliminated. 3. Sales of Lease Receivables The Company sells products to certain customers under sales-type lease arrangements. The Company accounts for its sales-type leases according to the provisions of Statement of Financial Accounting Standards (SFAS) No. 13, "Accounting for Leases," and accordingly, recognizes current and long-term lease receivables, net of unearned finance income on the accompanying balance sheets. The Company periodically sells lease receivables to various, unrelated financing companies. The Company accounts for its sales of lease receivables in accordance with SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - a Replacement of FASB Statement No. 125." In accordance with the criteria set forth in SFAS No. 140, lease receivables amounting to $13.7 million were sold during the quarter ended March 31, 2004. In the same quarter of the previous year, lease receivables amounting to $4.7 million were sold. - 6 - 4. Capitalized Software The Company is implementing an enterprise resource planning (ERP) system to replace its current fulfillment system. Implementation of the ERP system is designed to improve management information and gain operating efficiencies. As of March 31, 2004 the Company has approximately $5.8 million of costs capitalized related to this project, of which approximately $1.8 million was capitalized in the three month period ended March 31, 2004. 5. Notes Payable to Banks The Company has a $125 million credit facility with a group of banks (the Credit Facility). The Credit Facility, which matures on February 28, 2005, 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 the Company's assets. Borrowing under the Wholesale Financing Facility is limited to 100% of the value of the inventory. The Wholesale Financing Facility is secured by the underlying inventory. The Credit Facility carries an interest rate indexed to LIBOR plus 1.75 percentage points. The Credit Facility also contains certain covenants as well as provisions specifying compliance with certain quarterly and annual financial ratios. At March 31, 2004, the Company was in compliance with all financial covenants set forth in the Credit Facility and had additional available credit on the Credit Facility of $70.3 million. 6. Accrued Warranty Liabilities The Company offers warranties on sales under certain products specific to the terms of the customer agreements. Standard warranties require repair or replacement of defective products reported during the warranty period at no cost to the customer. The Company records an estimate for warranty expenses based on its actual historical return rates and repair costs at the time of sale. Accrued warranty liability as of December 31, 2003 $ 4,555 Warranty activity from January 1, 2004 to March 31, 2004: Charges made against the warranty (538) Accruals related to warranty 478 ------- Net change to accrued warranty liability during period (60) ------- Accrued warranty as of March 31, 2004 $ 4,495 ======= - 7 - 7. Earnings Per Share The following table sets forth the components of basic and diluted earnings per share: Three months ended March 31, 2004 2003 ------- ------- Basic loss per share: Net loss (numerator) ($1,381) ($1,763) Weighted average shares outstanding (denominator) 8,556 8,564 ------- ------- Basic loss per share ($ 0.16) ($ 0.21) ======= ======= Diluted loss per share: Net loss (numerator) ($1,381) ($1,763) Denominator: Weighted average shares outstanding 8,556 8,564 Effect of dilutive securities: Employee stock options *N/A *N/A ------- ------- Denominator for dilutive loss per share 8,556 8,564 ------- ------- Dilutive loss per share ($ 0.16) ($ 0.21) ======= ======= * At March 31 2004 and 2003 there were approximately 924,000 and 803,000 shares, respectively, of potentially dilutive options that are not included because the net losses for the quarters makes their impact anti-dilutive. - 8 - 8. Stock Option Accounting The Company has chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principle Board (APB) Opinion No. 25 "Accounting for Stock Issued to Employees" and related interpretations. Accordingly, compensation expense for stock options is measured as the excess, if any, of the fair market value of the Company's stock at the date of the grant over the exercise price of the related option. Had compensation costs for the Company's stock options been determined based on SFAS No. 123 "Accounting for Stock Based Compensation" using an accepted fair valuation method, the Company's net income and earnings per share would have been as follows (in thousands, except per share amounts): Three Months Ended March 31, 2004 2003 ------- --------- Net loss - as reported ($1,381) ($ 1,763) Add: Total stock-based employee compensation expense as reported under intrinsic value method (APB No. 25) for all awards, net of related tax effects -- -- Deduct: Total stock-based employee compensation expense determined under fair value based method (SFAS No. 123) for all awards, net of related tax effects (830) (410) ------- --------- Net loss - pro forma ($2,211) ($ 2,173) ======= ========= Net loss per share - as reported (basic) ($0.16) ($0.21) ======= ========= Net loss per share - as reported (diluted) ($0.16) ($0.21) ======= ========= Net loss per share - pro forma (basic) ($0.26) ($0.25) ======= ========= Net loss per share - pro forma (diluted) ($0.26) ($0.25) ======= ========= 9. Commitments and Contingencies The Company is occasionally a defendant in litigation incidental to its business. The Company believes that none of such litigation currently pending against it, individually or in the aggregate, will have a material adverse effect on the Company's financial condition or results of operations. In November 2003, GTSI was served with a $25 million lawsuit, with treble damages, related to the termination of a former subcontractor. This suit follows the Company's earlier lawsuit against the former subcontractor. Management believes these claims are without merit and intends to vigorously defend this lawsuit, but the ultimate outcome of this matter is uncertain. Management is unable to estimate the amount GTSI may have to pay related to this matter. No amounts have been accrued as of March 31, 2004. - 9 - ITEM 2. 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, the Consolidated Financial Statements and Notes thereto included elsewhere in this Report, as well as the Company's consolidated financial statements and notes thereto incorporated into its Annual Report on Form 10-K for the year ended December 31, 2003. 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. First Quarter 2004 Overview Historically, the Company has experienced net losses in the first quarter of the year due to the buying pattern of the Government. For the first quarter of 2004, the Company experienced a year over year improvement to its net loss despite a minimal change in revenues in the period. The Company saw an increase in bookings for the quarter driven by a strong month of March. Backlog as of March 31, 2004 increased to $98.0 million from $72.2 million as of March 31, 2003. Gross margin increased $2.0 million to $18.1 million due primarily to higher vendor volume incentive payments. The Company continues to focus its sales efforts on vendors that are offering these volume incentive programs and its sales force is given incentives to sell these vendors products. Operating expenses for the period also increased by $2.0 million. During the quarter the Company incurred costs related to three major initiatives. First, the Company introduced its new branding campaign, "I Rely on GTSI". The Company also incurred expenses related to its efforts to comply with the requirements set forth by Section 404 of the Sarbanes-Oxley Act (SOX 404). Finally, the Company continued to invest in its implementation of enterprise resource planning (ERP) system to replace its current fulfillment system. Offsetting the increase in operating expenses, the Company's interest and other income increased by $0.6 million to $1.4 million due to an increase in lease interest income from the sale of leases of equipment to government customers. Company Overview GTSI is a recognized information technology (IT) solutions leader, providing products and services to federal, state, and local government customers worldwide. For over two decades GTSI has served the public sector by teaming up with global IT leaders such as HP, Panasonic, Microsoft, Sun and Cisco. GTSI seeks to deliver maximum value through its broad range of products, extensive contract portfolio, and ISO 9002-registered logistics. Through its Technology Teams, GTSI delivers "best of breed" products and services to help its customers realize strong value for their IT investments. The Technology Teams consist of technical experts who support a wide range of integrated IT solutions in such areas as high performance computing, advanced networking, mobile and wireless solutions, high availability storage and information assurance. GTSI continues to broaden its leadership in electronic commerce and procurement through its federally focused website, gtsi.com that provides customized shopping zones to meet customers' personalized needs. GTSI is headquartered in Northern Virginia, outside of Washington, D.C. Federal Government IT spending has grown at a 14% compounded annual rate since 2000, and the Company believes that government IT spending will continue to be robust in the foreseeable future. The Company's revenue has grown at a 13% compounded annual rate since 2000. Changes in sales throughout the Company's history have been attributable to increased or decreased unit sales, to expansion of the Company's product offerings (e.g., peripherals, personal computers and networking, Unix servers/workstation and internet products), to the addition/removal of vendors, and to the addition or expiration of sales contract vehicles. - 10 - A substantial portion of the Company's contracts is fixed-price and indefinite delivery/ indefinite quantity ("IDIQ"). The uncertainties related to future contract performance costs, product life cycles, quantities to be shipped and delivery dates, among other factors, make it difficult to predict the future sales and profits, if any, which may result from such contracts. GTSI qualified as a "small business" under several of the GWACs and BPAs it holds based upon GTSI's size status at the time of the contracts' original award. As a small business, GTSI enjoys a number of benefits, including being able to compete for small business set-aside contracts, 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 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 by GSA on October 10, 2002, 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 contract awards 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. GTSI cannot predict whether it would continue to qualify as a small business at the time of recertification. To mitigate any potential adverse impact, GTSI has developed strategic relationships with small minority-owned businesses that benefit from the small business benefits described above. GTSI acts as both a supplier and prime contractor to these small minority-owned businesses. Legislation is periodically introduced in Congress that may change the federal government's procurement practices, and agencies from time to time may issue new regulations or modify existing regulations that may also change the government's procurement practices. GTSI cannot predict whether any legislative or regulatory proposals will be adopted or, if adopted, the impact upon its operating results. Changes in the structure, composition and/or buying patterns of the Government, either alone or in combination with competitive conditions or other factors, could adversely affect future results. Noncompliance with Government procurement regulations or contract provisions could result in termination of Government contracts, substantial monetary fines or damages, suspension or debarment from doing business with the Government and civil or criminal liability. During the term of any suspension or debarment by any Government agency, the contractor could be prohibited from competing for or being awarded any contract by any Government agency. In addition, substantially all of the Company's Government contracts are terminable at any time at the Government's convenience or upon default. Upon termination of a Government contract for default, the Government may also seek to recover from the defaulting contractor the increased costs of procuring the specified goods and services from a different contractor. The effect of any of these possible Government actions or the adoption of new or modified procurement regulations or practices could adversely affect the Company. The Company's business strategy is to continue to focus on higher-end product-based solutions, to broaden its product offering, and to remain a low-cost, and high-reliability provider of commodity products. The Company also focuses on bringing new technologies to government customers. - 11 - Results of Operations The following table sets forth, for the periods indicated, the percentages that selected items within the statement of operations bear to sales and the annual percentage changes in the dollar amounts of such items. Percentage of Sales Three months ended March 31, 2004 2003 ------ ------ Sales 100.0% 100.0% Cost of sales 89.9 91.0 ------ ------ Gross margin 10.1 9.0 ------ ------ Operating expenses: Selling, general, and administrative 11.7 10.6 Depreciation and amortization 0.4 0.4 ------ ------ Total operating expenses 12.1 11.0 ------ ------ Loss from operations (2.0) (2.0) Interest and other income, net 0.7 0.4 ------ ------ Loss before taxes (1.3) (1.6) Income tax benefit (0.5) (0.6) ------ ------ Net loss (0.8) (1.0) ====== ====== - 12 - The following tables set forth, for the periods indicated, the approximate sales by product, by contract vehicle and by vendor, along with related percentages of total sales. Contract Vehicles Three months ended March 31, (Dollars in thousands) 2004 2003 ----------------- ----------------- GSA Schedules $ 42,208 23.7% $ 51,864 29.0% IDIQ Contracts 72,926 40.8% 78,927 44.1% Open Market 35,937 20.1% 26,948 15.1% Subcontracts and Other Contracts 27,552 15.4% 21,119 11.8% -------- ----- -------- ----- Total $178,623 100.0% $178,858 100.0% ======== ===== ======== ===== Top 5 Vendors Three months ended March 31, (Dollars in thousands) 2004 2003 ----------------- ----------------- Panasonic $ 34,402 19.3% $ 34,833 19.5% HP 18,805 10.5% 31,027 17.3% Cisco 23,119 12.9% 20,440 11.4% Sun 20,354 11.4% 19,675 11.0% Dell 12,069 6.8% 9,854 5.6% Other 69,874 39.1% 63,029 35.2% -------- ----- -------- ----- Total $178,623 100.0% $178,858 100.0% ======== ===== ======== ===== Product Category Three months ended March 31, (Dollars in thousands) 2004 2003 ----------------- ----------------- Hardware $139,911 78.3% $128,929 72.1% Software 19,818 11.1% 28,995 16.2% Services* 18,894 10.6% 20,934 11.7% -------- ----- -------- ----- Total $178,623 100.0% $178,858 100.0% ======== ===== ======== ===== * For the three months ended March 31, 2004 and 2003, services include approximately $17.8 million and $16.4 million of resold, third-party services and maintenance contracts, respectively. Services also include approximately $1.1 million and $4.5 million of consulting and other services that we provided either through our own business resources or through our alliance partners for the three months ended March 31, 2004 and 2003, respectively. - 13 - Three Months Ended March 31, 2004 Compared With the Three Months Ended March 31, 2003 Sales. Sales consist of revenues from product shipments and services rendered net of allowances for customer returns and credits. Revenues for the first quarter of 2004 were relatively flat at $178.6 million, compared to $178.9 million in the first quarter of 2003. Open market sales are up $9.0 million or 33.4% for the quarter due in part to the increase in other vendors. The Company continues to have new vendors come to GTSI for its expertise with government procurement. In some cases, these new vendors will flow through as an open market sale until programs teams have had time to determine which contracts, if any, the vendor's product line best fits. Subcontracts and Other Contracts sales increased $6.4 million or 30.0% due to increased volume of sales with prime contractors and increased sales to state and local customers under the US Communities Contract. The Company created a new Integrator Solution Group during 2003 that is focused on creating relationships with large system integrators within the Government and private sectors. GSA schedules sales are down $9.7 million or 18.6% due to the expedition of two major Blanket Purchase Agreements ("BPAs"). Sales on IDIQ contracts are down $6.0 million or 7.6% for the quarter. Backlog. The Company recognizes an order in its backlog at the time it receives and accepts a written customer purchase order. The Company's Total Backlog includes orders that have not shipped ("Unshipped Backlog") as well as orders that have shipped but not delivered at the period end. Total Backlog at March 31, 2004 was approximately $98.0 million compared to $72.2 million at March 31, 2003. Unshipped Backlog at March 31, 2004 was approximately $87.9 million compared to $65.1 million at March 31, 2003. Backlogs fluctuate significantly from quarter to quarter because of the seasonality of Government ordering patterns and fluctuations in inventory availability of various products. Gross Margin. Gross margin is sales less cost of goods sold, which includes product cost, freight, warranty maintenance cost and certain other expenses related to the cost of acquiring products. Gross margin for the first quarter 2004 increased $2.0 million to $18.1 million compared to $16.1 million in the same quarter of 2003. The increase is primarily due to higher vendor volume incentive payments. The Company continues to focus its sales efforts to vendors that are offering these volume incentive programs and its sales force is given incentives to sell these vendors products. Gross margin as a percentage of total sales in the first quarter of 2004 increased to 10.1% of total sales from 9.0% of total sales in the same quarter of 2003. Gross margin percentages vary over time and may change significantly depending on the mix of customer's use of available contract vehicles and the mix of product sold. Operating Expenses. Total operating expenses for the three months ended March 31, 2004 increased $2.0 million to $21.7 million from the same period in 2003. Expressed as a percentage of total sales, total operating expenses increased to 12.1% from 11.0% in the same quarter last year. The increase in operating expense was partially driven by increased outside services expenses related to our SOX 404 efforts, our new ERP system implementation, and our "I Rely on GTSI" marketing campaign. Interest and Other Income, Net. Net interest and other income in the first quarter of 2004 increased to $1.3 million compared to $0.7 million in the same period in 2003 due primarily to an increase in interest income from equipment leases offset by a decrease in prompt payment discounts from vendors. The Company continues to take advantage of prompt payment discounts when offered by vendors. However, due to lower interest rates, the Company's vendors have reduced their prompt payment programs. Income Tax. The Company recorded a tax benefit of $0.9 million for the first quarter of 2004 based on the effective rate of approximately 39.5% compared to a tax benefit of $1.1 million in the same period last year. - 14 - Effect of Inflation The Company believes that inflation has not had a material effect on its operations. If, however, inflation increases in the future it could temporarily adversely affect the profitability of GTSI's sales under its government fixed-price contracts, which generally preclude the Company from passing on inflation-related or other increases in product costs to Government customers during the term of a pre-existing contract. The Company mitigates this risk in part by often obtaining agreements from certain of its suppliers prohibiting them from increasing their prices to GTSI during fixed-price, term contracts. Seasonal Fluctuations and Other Factors The Company has historically experienced and expects to continue to experience significant seasonal fluctuations in its operations as a result of government buying and funding patterns, which also affect the buying patterns of GTSI's prime contractor customers. These buying and funding patterns historically have had a significant positive effect on GTSI's bookings in the third quarter ending September 30 each year (the federal government's fiscal year end), and consequently on sales and net income in the third and fourth quarters of each year. Quarterly financial results are also affected by the timing of the award of and shipments of products under government contracts, price competition in the computer and IT industries, the addition of personnel or other expenses in anticipation of sales growth, product line changes and expansions, and the timing and costs of changes in customer and product mix. In addition, customer order deferrals in anticipation of new product releases by leading hardware and software manufacturers, delays in vendor shipments of new or existing products, a shift in sales mix to more complex requirements contracts with more complex service costs, and vendor delays in the processing of incentives and credits due GTSI, have occurred (all of which are also likely to occur in the future) and have adversely affected the Company's operating performance in particular periods. The seasonality and the unpredictability of the factors affecting such seasonality make GTSI's quarterly and yearly financial results difficult to predict and subject to significant fluctuation. The Company's stock price could be adversely affected if any such financial results fail to meet the financial community's expectations. Additionally, legislation is periodically introduced in Congress that may change the federal government's procurement practices, and agencies from time to time may issue new regulations or modify existing regulations that may also change the government's procurement practices. GTSI cannot predict whether any legislative or regulatory proposals will be adopted or, if adopted, the impact upon its operating results. Changes in the structure, composition and/or buying patterns of the Government, either alone or in combination with competitive conditions or other factors, could adversely affect future results. New Accounting Pronouncements In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities (FIN No. 46). FIN No. 46 clarifies the application of Accounting Research Bulletin No. 51, "Consolidated Financial Statements", to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from the other parties. FIN No. 46 applies to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after December 15, 2003, which is the Company's first quarter of fiscal year 2004. The Company has adopted of FIN No. 46 with no material impact on its condensed consolidated financial statements. - 15 - Liquidity and Capital Resources During the first three months of 2004, the Company's operating activities provided $35.5 million of cash flow, compared to the $16.9 million of cash flow provided during the same period in 2003. In the first quarter of the year the Company's cash flow benefits from the change in the Company's revenue seasonality. The main increase in operating cash flow was due to the increased collections of accounts receivables during the first quarter. Investing activities used cash of approximately $1.9 million during the three months ended March 31, 2004, compared to $2.2 million for the same period in 2003 reflecting the Company's investment in software for a new fulfillment system, intended to improve efficiency throughout the Company. As of March 31, 2004, the Company has capitalized approximately $5.8 million under this project. The Company will continue to invest in this project throughout 2004. During the three months ended March 31, 2004, the Company's financing activities used cash of approximately $12.3 million primarily to repay borrowings under the Company's Credit Facilities. The Company has a $125 million credit facility with a group of banks (the "Credit Facility"). The Credit Facility, which matures on February 28, 2005, 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 the Company's assets. Borrowing under the Wholesale Financing Facility is limited to 100% of the value of the inventory. The Wholesale Financing Facility is secured by the underlying inventory. The Credit Facility carries an interest rate indexed to LIBOR plus 1.75 percentage points. The Credit Facility also contains certain covenants as well as provisions specifying compliance with certain quarterly and annual financial ratios. At March 31, 2004, the Company was in compliance with all financial covenants set forth in the Credit Facility and had additional available credit on the Credit Facility of $70.3 million. The Company anticipates that it will continue to rely primarily on operating cash flow, bank loans and vendor credit to finance its operating cash needs. The Company believes that such funds should be sufficient to satisfy the Company's near term anticipated cash requirements for operations. Nonetheless, the Company may seek additional sources of capital, including permanent financing over a longer term at fixed rates, to finance its working capital requirements. The Company believes that such capital sources will be available to it on acceptable terms, if needed. Sarbanes-Oxley Section 404 The Company is working to comply with the requirements set of Section 404 of the Sarbanes-Oxley Act. Under SOX 404, the Company is required to attest to the effectiveness of its internal controls as of December 31, 2004. At this time it is not clear as to the total cost the Company will incur as a result of this compliance effort. During the first quarter of 2004, the Company expensed approximately $0.1 million on this effort and expects cost to increase during the second and subsequent quarters. - 16 - "Safe Harbor" Statement under the Private Securities Litigation Reform Act of 1995 Except for historical information, all of the statements, expectations, beliefs, anticipations, intentions, and assumptions contained in the foregoing material are "forward-looking statements" (within the meaning of the Private Securities Litigation Reform Act of 1995, as amended) that involve a number of risks and uncertainties. All such forward-looking statements are intended to be subject to the safe harbor protection provided by the Private Securities Reform Act of 1995, as amended, and by other applicable securities laws. It is possible that the assumptions made by management -- including, but not limited to, those relating to the cost of and compliance with Sarbanes-Oxley Section 404, favorable gross margins, a favorable mix of contracts, benefits of a more efficient operation, future contract awards, returns on new product programs, profitability, recovery of the costs of inventory, and increased control of operating costs -- may not materialize. Actual results may differ materially from those projected or implied in any forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis only as of the date hereof. The Company undertakes no obligation to revise publicly the forward-looking statements to reflect events or circumstances that arise after the date hereof. Readers should carefully review the risks factors described in other documents the Company files from time to time with the Securities and Exchange Commission, including the Quarterly Reports on the Form 10-Q and Annual Report on Form 10-K to be filed by the Company subsequent to this Quarterly Report on Form 10-Q and any Current Reports on Form 8-K filed by the Company. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company had a $125.0 million credit facility indexed at LIBOR plus 1.75 percentage points as of March 31, 2004. This variable rate credit facility subjects the Company to potential borrowing costs exposure resulting from changes in interest rates. In recent years, the Company has not borrowed such significant amounts that any movement in interest rates has had a material effect on its earnings or cash flows. Accordingly, at current borrowing levels, the Company does not believe that any move in interest rates would have such an effect. If the Company were to increase borrowings under its Credit Facility significantly, then future interest rate changes could potentially have such a material impact on earnings. ITEM 4. CONTROLS AND PROCEDURES (a) Evaluation of disclosure controls and procedures As of the end of the 90 day period covered by this report, the Company carried out an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures pursuant to Exchange Act Rule 13a-15 under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that that Company's disclosure controls and procedures are effective. Disclosure controls and procedures are controls and procedures that are designed to ensure that information required to be disclosed in the Company's reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. (b) Changes in internal controls There were no significant changes in our internal controls or in other factors that could significantly affect our internal controls subsequent to the Evaluation Date. - 17 - PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEDURES In November 2003, GTSI was servied with a $25 million lawsuit, with treble damages, related to the termination of a former subcontractor. This suit follows the Company's earlier lawsuit against the former subcontractor. Management believes those claims are without merit and intends to vigorously defend this lawsuit, but the ultimate outcome of this matter is uncertain. Management is unable to estimate the amount GTSI may have to pay related to this matter. No amounts have been accrued as of March 31, 2004. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: 31.1 Section 302 Certification of Chief Executive Officer 31.2 Section 302 Certification of Chief Financial Officer 32 Section 906 Certificatino of Chief Executive Officer and Chief Financial Officer (b) Reports on Form 8-K: On February 17, 2004, GTSI filed a report on Form 8-K under Item 12 relating to its press release of financial information for the three and twelve-month periods ending December 31, 2003, and monthly sales information." - 18 - SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Date: May 10, 2004 GTSI Corp. By: /s/ DENDY YOUNG ------------------------------------------------------ Dendy Young Chairman and Chief Executive Officer By: /s/ THOMAS A. MUTRYN ------------------------------------------------------ Thomas A. Mutryn Senior Vice President and Chief Financial Officer - 19 -