**As
        filed with the Securities and Exchange Commission on March 26,
        2007**


**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


Washington,
      D.C. 20549





**FORM
      10-KSB**





**[X]
      ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF**


**THE
      SECURITIES EXCHANGE ACT OF 1934**


For
      the
      fiscal year ended December 31, 2006





**[
      ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF**


**THE
      SECURITIES EXCHANGE ACT OF 1934**


For
      the
      transition period from ________ to ________







**Commission
      File No.: 000-07539**





**QSGI
      INC.**


(Exact
      name of small business issuer as specified in its charter)





**Delaware**
              (State
                or other jurisdiction of
              incorporation
                or organization)****
            **13-2599131**
              (I.R.S.
                Employer
              Identification
                No.)





**400
      Royal Palm Way, Palm Beach, FL 33480**


(Address
      of Principal Executive Offices) (Zip Code)





**(561)
      835-9747**


(Issuer’s
      Telephone Number)




**Securities
      registered under Section 12(b) of the Exchange Act: None**




**Securities
      registered under Section 12(g) of the Exchange Act: Common Stock, $.01 par
      value**




Check
      whether the issuer is not required to file reports pursuant to Section 13 or
      15(d) of the Exchange Act [ ]




Check
      whether the issuer: (1) filed all reports required to be filed by Section 13
      or
      15(d) of the Exchange Act during the past 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 [ ]




Check
      if
      there is no disclosure of delinquent filers in response to Item 405 of
      Regulation S-B contained in this form, and no disclosures will 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-KSB or any
      amendment to this Form 10-KSB. [ ]




Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act). Yes [ ] No [X]




Issuer’s
      revenues for its most recent fiscal year: $46,408,917




The
      aggregate market value of the voting stock, $.01 par value, held by
      non-affiliates of the Registrant, based upon the closing price of Common Stock
      on March 1, 2007, as reported on the OTCBB under the symbol “QSGI.OB,” was
      approximately $32,731,351 (31,172,716 shares x $1.05 per share). There is no
      officer who owns more than 10% of the shares of Common Stock.
















The
      number of shares outstanding of each class of our common equity as of March
      1,
      2007 is as follows:




Class
                of Common Equity
            
            Number
                of SharesCommon
                Stock, par value $.01
            
            31,172,716




A
      description of “Documents Incorporated by Reference” is contained in Item 13
      Exhibits and Financials Statements.




Transitional
      Small Business Disclosure Format (check one): Yes [ ] No [X]







**Table
                Of Contents****Item**
            **Description**
            **Page****Part
                I**1.
            Description
                of Business
            12.
            Description
                of Property
            93.
            Legal
                Proceedings
            104.
            Submissions
                of Matters to a Vote of Security
                Holders
            11**Part
                II**5
            Market
                for Common Equity and Related Stockholder
                Matters
            116
            Management’s
                Discussion And Analysis of Financial Condition
                and Results of Operations
            167.
            Financial
                Statements
            318.
            Changes
                in and Disagreements with Accountants on Accounting
                and Financial Disclosure
            318A.
            Controls
                and Procedures
            32**Part
                III**9.
            Directors,
                Executive Officers, Promoters and Control
                Persons; Compliance With Section 16(a) of the Exchange
                Act
            3210.
            Executive
                Compensation
            3511.
            Security
                Ownership of Certain Beneficial Owners and
                Management and Related Stockholder Matters
            4312.
            Certain
                Relationships and Related Transactions
            4413.
            Exhibits
            4614.
            Principal
                Accountant Fees and Services
            46Signatures
            47Financial
                Statements and Exhibits
            48









**PART
      I**




**Item
      1.**   **Description
      of Business**




**Forward-Looking
      Statements And Associated Risk**




The
      following discussion should be read in conjunction with our audited Financial
      Statements and Notes thereto included herein.




Certain
      statements in this Report constitute “forward-looking statements” within the
      meaning of Section 27A of the Securities Act of 1933, Section 21E of the
      Securities Exchange Act of 1934 and the Private Securities Litigation Reform
      Act
      of 1995. We intend that such forward-looking statements be subject to the safe
      harbors created thereby.




All
      such
      forward-looking information involves risks and uncertainties and may be affected
      by many factors, some of which are beyond our control. These factors
      include:


·
            Our
                growth strategies.


·
            Anticipated
                trends in our business and
                demographics.


·
            Our
                ability to successfully integrate the business operations of recently
                acquired companies; and ·
            Regulatory, competitive or other economic
              influences.




Forward-looking
      statements involve known and unknown risks, uncertainties and other factors
      which may cause our actual results, performance or achievements to be materially
      different from any future results, performance or achievements expressed or
      implied by such forward-looking statements. Such factors include, among others,
      the following: our continued ability to sustain our growth through continuing
      vendor relationships; the successful consummation and integration of future
      acquisitions; the ability to hire and retain key personnel; the continued
      development of our technical, manufacturing, sales, marketing and management
      capabilities; relationships with and dependence on third-party suppliers;
      anticipated competition; uncertainties relating to economic conditions where
      we
      operate; uncertainties relating to government and regulatory policies;
      uncertainties relating to customer plans and commitments; rapid technological
      developments and obsolescence in the products we sell and the industries in
      which we operate and compete; existing and potential performance issues with
      suppliers and customers; governmental export and import policies; global trade
      policies; worldwide political stability and economic growth; the highly
      competitive environment in which we operate; potential entry of new,
      well-capitalized competitors into our markets; and changes in our capital
      structure and cost of capital. The words “believe”, “expect”, “anticipate”,
“intend” and “plan” and similar expressions identify forward-looking statements.
      Readers are cautioned not to place undue reliance on these forward-looking
      statements, which speak only as of the date the statement was
      made.




**References**




References
      in this form 10-KSB to “we”, “us,” “our,” “the Company,” “WindsorTech,” and
“QSGI” mean QSGI INC. and our subsidiaries, unless the context otherwise
      requires.




1




**What
      We Do**





We
      are a
      technology services company. Our Data Security and Compliance services as well
      as our Data Center Hardware and Data Center Maintenance services are geared
      towards both the users of business-computing hardware (desktops, laptops,
      related peripherals and servers) as well as the users of enterprise-class
      hardware (mainframes, midrange processors, large storage, controllers, etc.).
      We
      use the trade name “QSGI” in order to build cohesion among the various
      technology services that we offer and build brand recognition and preference
      through strong cross-marketing opportunities.





**Segments**





Our
      company operates in three segments that clearly focus our services into
      easy-to-understand categories for our target customers:





**A.**
            **Data
                Security & Compliance**





We
      provide data security and regulatory compliance services for end-of-life
      business-computing Information Technology (IT) assets. We offer a variety of
      solutions to companies whose business computing technologies (desktops, laptops,
      printers, servers and enterprise storage systems) have come to the end of their
      life cycle. These services include:


-
      Data
      erasure to Department of Defense standards for hard drives


-
      Asset
      Auditing/Life Cycle Management, which allows customers to minimize their overall
      IT expenditure and maximize their return on investment.


-
      IT
      asset remarketing for IT assets with market value


-
      Environmental compliance (proper recycling or safe disposal) for IT
      assets





These
      services can be custom tailored to meet our customer's needs and implemented
      at
      QSGI facilities or at one client location or at multiple client-site locations,
      through the use of one of our client-site solutions including our mobile audit
      and erasure truck and our client suitcase server.





**B.**
            **Data
                Center Hardware**





We
      are a
      leading reseller of refurbished enterprise-class hardware and associated
      peripheral products to companies around the world. We remarket refurbished
      IBM
      mainframe processors, IBM midrange processors and associated peripheral products
      including tape and disk products and connectivity products.





**C.**
            **Data
                Center Maintenance**





We
      provide hardware maintenance services for enterprise-class hardware and
      associated peripheral products and Data Center consulting to companies
      throughout the United States.





Across
      all three segments, we purchase excess, used, off-lease and refurbished hardware
      from a variety of sources including Fortune 1000 companies, as well as leasing
      and finance companies.





2




**Data
        Security & Compliance Segment:**
 
 We
        are a
“best practice” provider of data security and regulatory compliance services for
        end-of-life business-computing IT assets. We offer a variety of services
        on a
        global basis to help companies with these assets to ensure compliance with
        federal and state mandates regulating the donation or disposal of such assets.
 
 The
        primary services that we offer are:
 
 Data
        security and regulatory compliance services:
 §
            Auditing
                and Detagging 
 §
            Erasing
                of Hard Drive -
        Department of Defense standard 3x up to 99X hard drive data erasure with
        no
        human intervention
 -
        Automated process that generates a self validated digital certificate of
        erasure
 
 §
            Tape
                and Hard Drive Degaussing -
        for
        failed or older storage media, QSGI uses (on-site at a client location or
        in our
        QSGI facility) a DoD grade degaussing machine to permanently destroy the
        storage
        media.
 
 §
            Regulatory
                Compliance Certification and
                Indemnification -
        QSGI,
        through its data security processes, indemnifies our clients for all assets
        we
        process.  This is to ensure our clients exceed all federal, state and local
        regulatory compliance statutes
 
 §
            Real
                Time Extranet Reporting -
        All
        reporting of assets (processed on-site at a client’s location or in our QSGI
        facility) is performed online. Clients have access to each asset processed
        and
        can track the progress from pick up to final audit and erasure
 
 §
            Remarketing
                and Revenue Sharing Program -
        Remarketing services to reduce or eliminate fees associated with hard drive
        data
        erasure and auditing
 
 §
            EPA
                Compliant Recycling -
        All
        assets that need to be recycled are done via EPA approved partners
 
 Reverse
        Logistics:
 §
            Pack
                and ship service §
            Full
                logistics management 
 Client-Site
        Audit & Erasure Solutions:
 §
            Eliminating
                any risk even a single data breach that arises during transport from
                a
                client’s company’s facilities is why QSGI’s full suite of services
                described above, can be provided directly at the client’s facilities. QSGI
                provides all on-site services tailored to the client’s specific needs any
                where in the world regardless of the amount of equipment to be processed.
                QSGI’s current
                client-site Data Security & Compliance offerings
                include: 
 3
 §
            **High
                Volume Solution**—
                Mobile Audit & Erasure Vehicle Solution-All assets that need to be
                recycled are done via EPA approved
                partners 
 §
            **Mid
                Volume Solution**—
                Transportable On-Site Server Solution
                (OSS) 
 §
            **Low
                Volume & Multiple/Remote Site Solution—**Web-Based Or Wan-Deployed Disk Drive Erasure Solution as well as
                QSGI’s
                eraseyourharddrive.com   Our
        data
        security and destruction services help companies achieve regulatory compliance
        with federal legislation including:
 
 -
            **Gramm-Leach-Bliley
                Act**-
                Requires companies which engage in financial activities such as insurance
                companies, banks, brokerage firms, etc. to ensure the security and
                confidentiality of customer information and protect against anticipated
                threats or hazards to information. 
 -
            **Health
                Insurers Portability & Accounting Act of 1996 (HIPAA)**-
                Requires healthcare companies to ensure the confidentially of all
                protected health information and protect against anticipated threats
                or
                hazards to information. 
 -
            **Sarbanes-Oxley
                Act**-
                Requires all publicly traded companies to protect investors by improving
                the accuracy and reliability of corporate disclosures. Requires companies
                to track the complete life cycle of all IT assets for seven
                years. 
 -
            **FTC
                FACT Act**-
                Requires companies to protect consumers against unauthorized access
                to
                credit report information “in connection with the disposal” of computer
                and other records by erasure of hard
                drives. 
 -
            **Environmental
                Compliance -**requires
                that the recycling of computers and related products be managed in
                a
                manner that is protective of human health and the
                environment. 
 In
        summary, our services are designed to help our clients to:
 -
            reduce
                the burdens of liability associated with regulatory compliance of
                IT
                assets. -
            reduce
                the overall expense of achieving regulatory
                compliance. -
            reduce
                the total cost of ownership for IT
                hardware. -
            permit
                IT professionals to focus on rapid changes in technology, service
                their
                internal clients and make sure their IT infrastructure
              is
                proactively helping their company maintain a competitive edge in
                the
                marketplace. 
 The
        market is highly fragmented with critical legislation driving the demand.
        There
        is no other technology services company offering similar IT “life cycle”
services ranging from PCs to Mainframes.
 
 In
        addition, the Data Security and Compliance segment re-sells a wide range
        of used
        and refurbished computer products, including servers, laptop and desktop
        computers, monitors, PC processors, CD/DVD disk drives, modems, printers
        and
        memory.





4


Our
      Data
      Security & Compliance group has technical facilities in New Jersey, and
      sales, marketing and business development offices in New York, New Hampshire,
      Florida and one foreign country.





**Data
      Center Hardware Segment:**





We
      are a
      reseller of refurbished enterprise-class hardware and associated peripheral
      products to companies around the world. Our strength comes from a significant
      presence in worldwide markets as the leading provider of refurbished mainframes
      and associated peripherals. More importantly, in this hardware niche, there
      are
      no other significant competitors.





The
      enterprise-class products that we market include:


-
            IBM
                mainframe products


-
            IBM
                midrange products (AS/400 and
                RS/6000)


-
            IBM/OEM
                tape storage


-
            IBM/OEM
                disk storage


-
            Hitachi
                Data Systems (HDS) products


-
            EMC
                products


-
            Connectivity
                products, controllers and mainframe
                printers





Very
      few
      resellers of enterprise-class hardware are able to offer data center managers
      refurbished mainframe products as well as technical expertise across all
      hardware categories found in the typical data center.





Because
      enterprise-class hardware is designed and manufactured to be reliable spanning
      several years, an alternative - such as QSGI - to choosing “new” hardware offers
      significant savings to our target audience.





Businesses
      that have already made purchasing decisions and saved money in the secondary
      market understand that there is often a fine line between “latest” technology
      and “current” technology. IBM, for example, recently introduced the z90
      mainframe. This new hardware is able to perform a variety of functions that
      make
      it unique and attractive for “early adopters” and those that believe that having
      the “latest” is best. Others understand, however, that technology that is only
      one year old can easily meet their data center requirements - that year-old
      technology is still “current” for their purposes. Yet, the key difference is
      that those who choose “current” technology (as opposed to “latest”) do not
      absorb the initial depreciation and may pay only a fraction of the price of
      “new” technology.





Currently,
      IBM is the only manufacturer of mainframes in the world marketplace. This gives
      IBM the luxury of having no competition for new mainframes. The lack of
      competition for new mainframes creates a unique opportunity for us to sell
      used
      mainframes to customers needing to control capital budgets for IT
      hardware.





Technology
      that is introduced by IBM is often available in the used marketplace as early
      as
      9-12 months after being introduced as a result of companies merging data
      centers, upgrading to the latest technology, filing bankruptcy or when hardware
      goes off lease. In many instances, the hardware is shipped to our offices in
      Eagan, Minnesota, where it is tested, refurbished and typically upgraded.





The
      key
      to our success is rooted in the information we glean through our retail efforts
      and our wholesale efforts. QSGI is typically involved in greater than 80 percent
      of all refurbished mainframe bids in the United States. To source
      enterprise-class hardware, our wholesale efforts are aware of nearly all
      mainframes that are - or about to become - available in the world. Access to
      this database of clients allows us to cross-market our other services that
      we
      offer.





5


Our
      Data
      Center Hardware group has its technical facilities in Minnesota along with
      sales
      and marketing. In addition, it has technical and sales offices in Connecticut,
      Illinois and Indiana.





**Data
      Center Maintenance Segment:**





We
      provide hardware maintenance services on enterprise-class hardware and
      associated peripheral products to companies around the United States. Either
      as
      a separate service from the hardware sale or sold as a service along with a
      sale
      of hardware, our maintenance programs are a source of significant savings and
      reliability for clients.





Products
      we maintain include:


-
            IBM
                mainframe products


-
            IBM
                midrange products


-
            IBM/OEM
                tape storage


-
            IBM/OEM
                disk storage


-
            Hitachi
                Data Systems (HDS) products


-
            EMC
                products


-
            Connectivity
                products and controllers





Our
      competitive advantages that make our services valuable for our corporate
      end-users as well as leasing companies needing to manage “off-lease”
enterprise-class hardware include:


-
            our
                technical expertise.


-
            our
                ready access to a strategic inventory of critical back-up
                parts.


-
            our
                reduced pricing as compared to our
                competitors.


-
            our
                greater expertise on multiple platforms including the heart of the
                data
                center, “the Mainframe.”





All
      training and back-up parts management for Data Center Maintenance is located
      in
      Minnesota. In addition, we have technical coverage and sales offices in 20
      other
      states including Arkansas, Colorado, Illinois, Indiana, Kansas, Maine, Missouri,
      Michigan, Nebraska, New Jersey, New York, North Carolina, Ohio, Pennsylvania,
      South Carolina, Tennessee, Texas, Washington DC, Wisconsin and Wyoming.





**Dependence
      on Major Customers**




With
      the
      exception of several of our hardware maintenance contracts and data security
      contracts, which can be up to three years in length, we do not have any
      exclusive long-term arrangements with our customers for the continued sales
      of
      our products or services. At present, we operate primarily in the United States
      and have minimal assets in foreign countries.




We
      sell
      and deliver our technology services to customers throughout the United States
      and on 6 continents worldwide. For the years ended December 31, 2006 and 2005,
      sales to our top ten customers comprised 44% and 37% of our revenue,
      respectively. In 2005, Keystone Memory Group, a “related party” for accounting
      purposes, was one of our top ten customers.




A
      portion
      of our revenues is also derived from export sales. For the years ended December
      31, 2006, and 2005, export sales comprised 14% and 7% of revenue,
      respectively.




6


**Backlog**





Customers
      typically do not place recurring "long-term" orders with us, resulting in a
      limited order backlog at any point in time. Our failure to receive orders from
      customers on a continuous basis could have a material adverse effect on our
      financial condition, results of operations and cash flows given our lack of
      recurring orders.





**Employees**





As
      of
      March 1, 2007, we employed 68 full-time and 17 part-time employees. None of
      our
      employees are represented by a collective bargaining agreement, nor have we
      experienced any work stoppages. We consider our relations with our employees
      to
      be good. We depend on the continued service of our key technical, sales and
      senior management personnel, and our ability to attract and retain additional
      qualified personnel. If we are unable to hire and retain qualified personnel,
      our business will be seriously harmed.





**Available
      Information**





Our
      Internet website address is http://www.qsgi.com .
      We make
      available free of charge through our Internet website our annual report on
      Form
      10-KSB, quarterly reports on Form 10-QSB, current reports on Form 8-K and
      amendments to those reports filed as soon as reasonably practicable after we
      electronically file such material with, or furnish it to, the Securities and
      Exchange Commission.





**Compliance
      With Environmental Regulations**





Federal,
      state, and local laws or regulations which have been enacted or adopted
      regulating the discharge of materials into the environment have not had, and
      under present conditions we do not foresee that they will have, a material
      adverse effect on our capital expenditures, earnings, cash flows or our
      competitive position. We will continue to monitor our operations with respect
      to
      potential environmental issues and costs, including changes in legally mandated
      standards.





We
      recycle used equipment that may contain hazardous materials through Waste
      Management’s Recycle America - Asset Recovery Group (“ARG”) division. ARG, for a
      fee, manages commodities and materials for recycling in accordance with
      applicable local, state and federal laws, rules and regulations. Upon receipt
      of
      materials for recycling, ARG provides us with a Certification of Destruction
      that, in part, certifies that the materials were accepted for the purpose of
      recycling and/or destruction in accordance with all applicable standards
      including federal, state and local requirements.





**Recent
      Developments**




**Change
      in Authorized Share Capital**




On
      September 18, 2006, the majority shareholders approved an increase in the number
      of common shares which the Corporation is authorized to issue from Fifty-five
      Million (55,000,000) shares of Common Stock, par value $.01 per share, to
      Ninety-five Million (95,000,000) shares of Common Stock, par value $.01 per
      share. No change was made to the Five Million (5,000,000) shares of Preferred
      Stock, par value $.01 per share that the Company is authorized to issue.






7


**Other
      Information**




As
      of
      February 14, 2005, Joel L. Owens resigned as Chief Operating Officer. He continues
      his employment as Executive Vice-President of the Company’s Data Center Hardware
      and Data Center Services groups.




On
      March
      14, 2005, Seth A. Grossman, a member of the Company’s Board of Directors, was
      appointed President and Chief Operating Officer. He continues as a member of
      the
      Board of Directors.




On
      May 3,
      2005, the Company entered into a revolving line of credit agreement that
      provides for borrowings limited to the lesser of $4,250,000 or the borrowing
      base of 80% of eligible accounts receivable plus 40% of inventories and in
      certain circumstances 60% of eligible inventories, with eligible inventories
      not
      to exceed $1,500,000. Interest on this loan is payable monthly at the prime
      rate
      plus one percent (8.25% at December 31, 2005), with all principal and interest
      due April 1, 2007. This
      credit agreement was paid off and replaced on January 17, 2007 when the company
      entered into a revolving line of credit agreement with Wells Fargo N.A. that
      provides for borrowings limited to the lesser of $7,500,000 or the borrowing
      base of 85% of eligible accounts receivable plus 45% of inventories, with
      eligible inventories not to exceed $3,000,000.




On
      September 7, 2005, John F. Cunningham was appointed as a member of our board
      of
      directors to fill a vacancy, as the company expanded the board to seven members.
      On September 12, 2005, Geoffrey A. Smith was appointed a member of our board
      to
      fill a vacancy, as the Company expanded the board to seven members.




On
      September 13, 2005, the Company was confirmed on the Archipelago
      Exchange SM **** (ArcaEx®),
      and began trading on September 15, 2005, under the symbol “QGI.” The Company had
      previously been listed on the OTC Bulletin Board under the symbol “WSRT.OB.” On
      November 29, 2006, the Company voluntarily elected to de-list from the
      Archipelago Exchange and resume its previous listing on the OTC Bulletin Board
      under the symbol “QSGI.OB”.




On
      October 17, 2005, the Company held its annual shareholders meeting in Palm
      Beach, Florida and elected seven members to the Company’s Board of Directors to
      hold office until the Company’s Annual Meeting of Stockholders in 2006 or until
      their successors are duly elected and qualified; ratified the appointment of
      RubinBrown LLP as the Company’s independent certified public accountant for the
      fiscal year ending December 31, 2005; and ratified a change of name of the
      Company from WindsorTech, Inc. to QSGI INC.




On
      November 14, 2005, the Company filed Amendment No. 1 on Form 10-KSB/A
      to the Company’s Annual Report filed on Form 10-KSB for the year ended
      December 31, 2004, initially filed with the Securities and Exchange Commission
      on March 29, 2005, reflecting a restatement of the Consolidated Financial
      Statements of WindsorTech, Inc. and Subsidiaries for the year ended December
      31,
      2004. At the same time, the Company also filed Amendment No. 1 on
      Form 10-QSB/A (“Form 10-QSB/A”) to the Company’s Quarterly Report on
      Form 10-QSB for the quarterly period ended June 30, 2005, initially filed
      with the Securities and Exchange Commission (the “SEC”) on August 12, 2005,
      (“Original Filing”) reflecting a restatement of the Condensed Consolidated
      Financial Statements of WindsorTech, Inc. and Subsidiaries (the “Company”) for
      the three months and six months ended June 30, 2005 and 2004. The determination
      to restate these Financial Statements and other financial information was made
      as a result of management’s determination that the initial accounting for
      deferred income taxes related to the acquisition of Qualtech International
      Corporation and Qualtech Services Group, Inc. needed correction. The audited
      consolidated financial statements as of December 31, 2004 and for the year
      then
      ended were restated to reflect the proper accounting treatment.




8


On
      December 20, 2005, the Company completed a private placement with a group of
      investors for net proceeds of approximately $4.2 million. The Company received
      the proceeds in two payments. The first payment, net of offering costs, of
      $1,967,220 was received at the time of signing and approximately $2,200,000
      was
      received at the beginning of January 2006. The preferred securities issued
      in
      the private placement consist of 143,333 shares of 6% Series A Preferred Stock
      with a face value of $30.00 per share. The 6% dividend is payable quarterly
      in
      cash or additional preferred securities at the Company’s option. Each Series A
      Preferred Share is convertible into approximately 13.33 shares of our common
      stock. The Company can require the holders to convert if the Company’s common
      stock price maintains $2.75 for twenty consecutive business days. The Company
      can redeem the preferred securities at any time after December 10, 2007.
      Additionally, the holder may demand redemption in cash, for the original $30
      per
      share, at any time after December 10, 2010. Because these preferred securities
      are conditionally redeemable, they are classified as temporary equity in the
      balance sheet.




On
      December 21, 2005, the Company completed the repurchase and retirement of
      4,283,334 outstanding warrants, including 1,866,667 warrants exercisable at
      $1.50 per share and 2,416,667 warrants exercisable at $3.60 per share. The
      total
      purchase price for the warrants, including transaction costs, was $1,256,210
      in
      cash. These warrants, previously held by an institutional investor, were issued
      as part of the private placement that was completed in May 2004.




On
      June
      22, 2006, under the terms of the acquisition agreement, as amended, with
      Qualtech International Corporation and its affiliate, Qualtech Services Group,
      Inc. that was completed on May 28, 2004, additional merger consideration was
      paid to the selling shareholders. The selling shareholders were entitled to
      receive additional merger consideration in the form of restricted shares of
      the
      Company. 2,063,545 shares were issued at a value of approximately $1.66 per
      share resulting in additional goodwill in the amount of $3,432,089.




**Item
      2.**   **Description
      of Property**




Our
      Data
      Security and Compliance segment leases approximately 38,000 square feet of
      general warehouse and office space in Hightstown, New Jersey pursuant to a
      five-year lease at a current annual rental of approximately $174,000, escalating
      each year. In addition to fixed rentals, the real property lease requires the
      Company to pay all maintenance, real estate taxes and insurance. This facility,
      with approximately 34,000 feet of warehouse space, is in good condition and
      ideally suited to our business. This lease expires in September 2011. In
      addition, the company leases additional warehouse space pursuant to a month
      to
      month lease at a monthly rental of $1,500. These warehouses have sufficient
      capacity for our current and estimated future business needs.




This
      segment also leases the following space:




1.
            In
                Portsmouth, New Hampshire approximately 1,400 square feet of office
                space
                pursuant to a three-year lease at a current annual rental of approximately
                $30,000. This lease expires in October
                2007.




2.
            In
                New York, New York approximately 250 square feet of office space
                and
                shared services pursuant to a one-year lease at a current annual
                rental of
                approximately $31,000. This lease expires in August
                2007.




3.
            In
                Palm Beach, Florida approximately 1,600 square feet of office space
                pursuant to a 27 month lease at a current annual rental of approximately
                $54,000. This lease expires in March,
                2007.






9


Our
      Data
      Center Hardware and Data Center Maintenance segments lease approximately 30,000
      square feet of general warehouse and office space in Eagan, Minnesota pursuant
      to a five-year lease at a current rental of approximately $15,000 per month.
      This facility is in good condition and ideally suited to our existing business
      and has adequate and sufficient capacity for our current and estimated future
      business needs. This lease expires in October 2009.




**Item
      3.**   **Legal
      Proceedings**




On
      April
      19, 2004, David A. Loppert filed a Complaint against the Company in the Chancery
      Court of New Castle County, Delaware, Case No. 394-N, in which he asserted
      he
      remained a director and officer of the Company notwithstanding the Company’s
      position that he no longer held those positions. Settlement discussions were
      held and a dispute arose as to whether agreement had been reached.





On
      May
      14, 2004, Mr. Loppert filed a second lawsuit in the Chancery Court, Case No.
      441-N, in which he asserted that a settlement had been reached and that he
      would
      acknowledge that he was no longer an officer or director provided the Company
      delivered to him options to purchase 1.1 million shares of the Company’s common
      stock at $1.10 per share. The Company defended and asserted that final agreement
      had never been reached. However, on June 25, 2004, the Delaware Chancery Court
      ruled that an enforceable agreement had been reached and further ruled that
      the
      Company was required to pay Mr. Loppert’s legal fees related to this matter.
      Based upon the Court’s decision in this matter, Mr. Loppert continued as an
      employee of the Company through September 30, 2004. On July 27, 2004, the
      Company determined to appeal the Court’s ruling to the Delaware Supreme Court.




On
      November 18, 2004, the Company filed a Complaint against Mr. Loppert in the
      Circuit Court for Palm Beach County, Florida, Case No. 502004CA010870XXXXMB,
      in
      which the Company asserted that, if any settlement agreement had been reached
      between the Company and Mr. Loppert, such agreement had been induced by improper
      conduct and was thereby voidable.





On
      January 7, 2005, Mr. Loppert brought an action in the Superior Court of New
      Jersey, Case No. L000020-05, against two officers of the Company, Marc Sherman
      and Edward Cummings, and two former officers, Carl Saracino and Michael Sheerr,
      alleging that each owed Mr. Loppert approximately $110,000.00 in connection
      with
      loans made to each of them which were then loaned to the Company.





On
      January 31, 2005, the Delaware Supreme Court affirmed the Chancery Court’s June
      25, 2004 decision.





On
      March
      15, 2005, all claims and litigation between Mr. Loppert and the Company and
      Messrs. Sherman, Cummings, Saracino and Sheerr were resolved pursuant to an
      agreement. The Company, Mr. Loppert and each party released all opposing parties
      for all claims existing as of the date of settlement.





The
      Company is the Plaintiff in a suit now pending in the United States District
      Court, Southern District of Florida, QSGI v. Anysystems, et. al. In this suit,
      the Company seeks damages for losses incurred as a result of the Company's
      dealings and interactions with the named Defendants. The Company seeks
      compensatory damages of approximately $458,000.00, interest, attorneys fees
      and
      if allowed by the court, punitive damages. As of December 31, 2006, the Company
      has fully reserved for the loss.





The
      Company is party to various legal proceedings arising in the ordinary course
      of
      business. In the opinion of management, these proceedings are not likely to
      have
      a material adverse effect on the financial position, results of operations
      or
      cash flows of the Company. The estimate of potential impact on the Company
      could
      change in the future.




10




**Item
      4.**   **Submission
      of Matters to a Vote of Security Holders**




There
      were no submissions of matters to a vote of our security holders during the
      fourth quarter of our fiscal year ended December 31, 2006.




**PART
      II**




Item
      5.  Market
      for Common Equity and Related Stockholder matters




***Market
      Information***




The
      Company’s Common Stock is listed on the OTC Bulletin Board under the symbol
“QSGI.OB.” Our Common Stock became listed on this exchange on November 29, 2006.
      Prior to that date, our stock was listed on the ArcaEx exchange under the symbol
      “QGI.”





The
      following table sets forth, for the calendar periods indicated, the high and
      low
      sales prices per share for the Company’s Common Stock as reported on the OTC
      Bulletin Board.




**Years
                Ended December 31, 2006**
            **High**
            
            **Low**First
                Quarter
            
            $
                2.10
            
            $
                1.55Second
                Quarter
            
            1.85
            
            1.27Third
                Quarter
            
            1.74
            
            1.26Fourth
                Quarter
            
            1.56
            
            0.95**Years
                Ended December 31, 2005**First
                Quarter
            
            $
                4.40
            
            $
                2.50Second
                Quarter
            
            2.80
            
            1.37Third
                Quarter
            
            2.31
            
            1.47Fourth
                Quarter
            
            1.75
            
            1.00




***Holders***




As
      of
      March 1, 2007, there were approximately 3,300 holders of record of the Company’s
      Common Stock and the closing price was $1.05. Because many of the outstanding
      shares of the Company’s Common Stock are held by brokers and other institutions
      on behalf of shareholders, the Company is not able to estimate the total number
      of beneficial shareholders represented by these record holders.




***Dividends***




The
      Company has paid no cash or stock dividends on its Common Stock to date and
      does
      not anticipate paying any dividends on its Common Stock in the foreseeable
      future. The Company intends to use any earnings, which may be generated, to
      finance the growth of the businesses.




During
      2006, the Company paid $256,389 in dividends on its redeemable convertible
      preferred stock. The 6% dividend is payable quarterly in cash or additional
      preferred securities at the Company’s option. The company chose to pay all 2006
      dividends in cash.




11


The
      Board
      of Directors has the right to authorize the issuance of preferred stock, without
      further shareholder approval, the holders of which may have preferences over
      the
      holders of the Common Stock as to payment of dividends.




***Securities
      authorized for issuance under equity compensation plans***




Set
      forth
      in the table below is information, as of December 31, 2006, regarding securities
      authorized for issuance under equity compensation plans:




**Plan
                Category**
            **Number
                of Securities to be issued upon exercise of outstanding options,
                warrants
                and rights**
              **(a)**
            **Weighted-average
                exercise price of outstanding options, warrants and
                rights**
              **(b)**
            **Number
                of securities remaining available for future issuance under equity
                compensation plans (excluding securities reflected in column
                (a))**
              **(c)**Equity
                compensation plans
              approved
                by security holders
            8,421,834
            $1.879
            4,111,862Equity
                compensation plans
              not
                approved by security holders
            3,800,000
            $2.177
            -Total
            12,221,834
            $1.972
            4,111,862




***Equity
      Compensation Plan not Approved by Security Holders***




The
      material features of the plan are:




*Option
      Grant.* In
      October 2001, in connection with their initial employment, WindsorTech, Inc.
      (New Jersey Corporation) granted to Messrs. Cummings, Loppert, Saracino, Sherman
      and Sheerr and two other employees options to purchase an aggregate of 1,350,000
      shares of its common stock at $0.026 per share, exercisable at any time after
      October 1, 2001 and on or before December 31, 2010. The options granted were
      Non-Qualified Options and immediately vested.




*Death.* If the
      option recipient dies, his personal representative and/or beneficiary will
      have
      the right (which must be exercised not later than the option expiration date)
      to
      exercise the options to the extent they were not exercised at the time of the
      recipient’s death.




*Non-Transferability
      of Rights; Designation of Beneficiaries.* Except
      as provided below, the options cannot not be transferred by the recipient other
      than by will or the laws of descent and distribution, and, during the lifetime
      of the recipient, the options can be exercised only by the recipient, except
      that, during his lifetime, the recipient may transfer the options for no
      consideration to members of his immediate family or a trust for the benefit
      of
      himself and/or members of his immediate family subject to all of the provisions
      applicable to the options prior to the transfer.




*Withholding.*   The
      Company or any affiliate that employs the recipient has the right to deduct
      any
      sums that federal, state or local tax law requires to be withheld with respect
      to the exercise of the options or as otherwise may be required by such laws.
      The
      Company or any such affiliate may require, as a condition to issuing stock
      upon
      the exercise of the options, that the recipient or other person exercising
      the
      options pay a sum to cover any such taxes. In the alternative, the recipient
      or
      other person exercising the options may elect to pay such sums to the Company
      or
      the affiliate by delivering written notice of that election to the Company's
      corporate headquarters prior to or concurrently with exercise. There is no
      obligation that the recipient be advised of the existence of the tax or the
      amount that may be withheld.




12




*Changes
      in Capital Structure.* If there
      is any change in the capital structure of the Company, or if there is be any
      dividend upon the stock of the Company payable in stock or any other dividend
      payable in stock, or of there is a stock split, spin-off, split-up, spin-out,
      recapitalization, merger, consolidation, reorganization, combination or exchange
      of shares, the maximum aggregate number of shares with respect to which the
      options may be exercised and the number and the option price of the shares
      of
      stock with respect to which the options were granted, will be proportionately
      adjusted by the Company if, and to the extent, necessary to prevent dilution
      or
      enlargement of the rights of the recipient.




***Recent
      Sales of Unregistered Securities***




The
      following table lists all unregistered securities sold/issued by us in the
      last
      three years pursuant to Item 701 of Regulation S-B.




These
      shares were issued to the persons listed below in connection with (1)(2)(3)
      Private Placement Shares, (4) the acquisition, (5) the exercise of stock
      options, (6) the exercise of stock warrants, (7) services rendered, or (8)
      the
      acquisition.




**Name/Entity/Nature**
            **Date
                Issued**
            **Note**
            **Number
                of****Persons**
            **Issued
                For**
            **Number
                of**
              **Common**
              **Shares**




Stanley
                Adelman
            July
                - 03
            1
            1
            Private
                Placement Shares
            5,000Harvey
                Albert
            July
                - 03
            1
            1
            Private
                Placement Shares
            15,000Mike
                Belise & Linda A Gary
            July
                - 03
            1
            2
            Private
                Placement Shares
            71,429Bismark
                Intervest, Inc.
            July
                - 03
            1
            1
            Private
                Placement Shares
            300,000Edward
                L. Cummings
            July
                - 03
            1
            1
            Private
                Placement Shares
            61,200John
                R. Doss
            July
                - 03
            1
            1
            Private
                Placement Shares
            300,000Steven
                Gadon & Barbara Gadon
            July
                - 03
            1
            2
            Private
                Placement Shares
            85,000Andrew
                L. Granat
            July
                - 03
            1
            1
            Private
                Placement Shares
            15,000Alan
                J Haber
            July
                - 03
            1
            1
            Private
                Placement Shares
            3,000Barry
                S. Hanburger
            July
                - 03
            1
            1
            Private
                Placement Shares
            2,500Bernard
                & Carol Harris,
              JT
                TEN WROS
            July
                - 03
            1
            2
            Private
                Placement Shares
            2,000John
                D. Wright, cust for
              Jonathan
                Martin Harris, Minor
            July
                - 03
            1
            1
            Private
                Placement Shares
            1,000Rodney
                D. and Linda L. Johnson,
              JT
                TEN WROS
            July
                - 03
            1
            1
            Private
                Placement Shares
            2,000Craig
                G. Langweiler
            July
                - 03
            1
            2
            Private
                Placement Shares
            10,000Monte
                Lang & Lillian M Lang,
              JT
                TEN WROS
            July
                - 03
            1
            2
            Private
                Placement Shares
            30,000Max
                & Delayne Loppert,
              JT
                TEN WROS
            July
                - 03
            1
            1
            Private
                Placement Shares
            70,000Anne
                E.B. Loppert, Minor,
              David
                A. Loppert, Custodian
            July
                - 03
            1
            1
            Private
                Placement Shares
            43,500Jeffrey
                E.B. Loppert, Minor,
              David
                A. Loppert, Custodian
            July
                - 03
            1
            1
            Private
                Placement Shares
            43,500Martin
                Miller
            July
                - 03
            1
            1
            Private
                Placement Shares
            2,857










13
 
   **Name/Entity/Nature**
                **Date
                    Issued**
                **Note**
                **Number
                    of****Persons**
                **Issued
                    For**
                **Number
                    of**
                  **Common**
                  **Shares**


Robert
                & Penni Parker,
              JT
                TEN WROS
            July
                - 03
            1
            2
            Private
                Placement Shares
            14,300RBC
                Dain Rauscher Custodian,
              FBO
                Harvey Albert IRA
            July
                - 03
            1
            1
            Private
                Placement Shares
            20,000Lois
                G. Rosenberg
            July
                - 03
            1
            1
            Private
                Placement Shares
            500Paul
                Rosen & Wendy Rosen
            July
                - 03
            1
            2
            Private
                Placement Shares
            85,000Carl
                Saracino
            July
                - 03
            1
            1
            Private
                Placement Shares
            15,000Philip
                & Lilyan Sherman,
              JT
                TEN WROS
            July
                - 03
            1
            2
            Private
                Placement Shares
            20,000Michael
                P. Sheerr
            July
                - 03
            1
            1
            Private
                Placement Shares
            44,000Alexandra
                J. Sherman, Minor,
              Marc
                Sherman Custodian
            July
                - 03
            1
            1
            Private
                Placement Shares
            28,433Maximilian
                B. Sherman, Minor,
              Marc
                Sherman Custodian
            July
                - 03
            1
            1
            Private
                Placement Shares
            28,433Zachary
                T. Sherman, Minor,
              Marc
                Sherman Custodian
            July
                - 03
            1
            1
            Private
                Placement Shares
            28,434Jonathan
                E. Stoll
            July
                - 03
            1
            1
            Private
                Placement Shares
            2,500Gail
                M. Thompson
            July
                - 03
            1
            1
            Private
                Placement Shares
            1,000Jack
                B. Tull Sr.
            July
                - 03
            1
            1
            Private
                Placement Shares
            3,000John
                D. & Dorothy J. Wright,
              JT
                TEN WROS
            July
                - 03
            1
            2
            Private
                Placement Shares
            1,000Bismark
                Intervest, Inc.
            July
                - 03
            2
            1
            Private
                Placement Shares
            100,000Edith
                Newman Revocable Trust
            July
                - 03
            2
            1
            Private
                Placement Shares
            20,000Paul
                Lee Newman Roth IRA
            July
                - 03
            2
            1
            Private
                Placement Shares
            50,000Paul
                Lee Newman
            July
                - 03
            2
            1
            Private
                Placement Shares
            30,000Michael
                Weiss
            May
                - 04
            3
            1
            Private
                Placement Shares
            83,400Odin
                Partners, LP
            May
                - 04
            3
            1
            Private
                Placement Shares
            116,600Barron
                Partners, LP
            May
                - 04
            3
            1
            Private
                Placement Shares
            4,833,333Guerilla
                Partners, LP
            May
                - 04
            3
            1
            Private
                Placement Shares
            716,600Guerilla
                IRA Partners, LP
            May
                - 04
            3
            1
            Private
                Placement Shares
            83,400Bismark
                Investment
            May
                - 04
            3
            1
            Private
                Placement Shares
            166,667Joel
                Owens
            May
                - 04
            4
            1
            Acquisition
            1,715,911Jolene
                Owens
            May
                - 04
            4
            1
            Acquisition
            241,920Robert
                Jackson
            Nov
                - 04
            5
            1
            Exercise
                of Stock Options
            200,000Carl
                Saracino
            Nov
                - 04
            5
            1
            Exercise
                of Stock Options
            150,000Michael
                Sheerr
            Nov
                - 04
            5
            1
            Exercise
                of Stock Options
            150,000Guerilla
                IRA Partners, LP
            Oct
                - 04
            6
            1
            Exercise
                of Stock Warrants
            41,700Guerilla
                Partners, LP
            Oct
                - 04
            6
            1
            Exercise
                of Stock Warrants
            358,300Odin
                Partners, LP
            Oct
                - 04
            6
            1
            Exercise
                of Stock Warrants
            58,300Michael
                Weiss
            Oct
                - 04
            6
            1
            Exercise
                of Stock Warrants
            41,700Andrew
                T. Trailor
            Jul
                - 04
            7
            1
            Shares
                Issued for Services
            35,140Duncan
                J Farmer
            Jul
                - 04
            7
            1
            Shares
                Issued for Services
            35,141Alan
                Burger
            Jul
                - 04
            7
            1
            Shares
                Issued for Services
            35,141Andrew
                T. Trailor
            Dec
                - 04
            7
            1
            Shares
                Issued for Services
            6,000Alan
                Burger and Dana Burger,
              Joint
                Tenants
            Dec
                - 04
            7
            2
            Shares
                Issued for Services
            6,000






14




**Name/Entity/Nature**
              **Date
                  Issued**
              **Note**
              **Number
                  of****Persons**
              **Issued
                  For**
              **Number
                  of**
                **Common**
                **Shares**


Duncan
                J Farmer
            Dec
                - 04
            7
            1
            Shares
                Issued for Services
            6,000Lois
                Rosenberg
            Jan
                - 05
            5
            1
            Exercise
                of Stock Options
            125,000Robert
                Jackson
            Jan
                - 05
            5
            1
            Exercise
                of Stock Options
            75,000David
                A. Loppert
            Jan
                - 05
            5
            1
            Exercise
                of Stock Options
            375,000Brian
                Cockerham
            Feb
                - 05
            5
            N
            Exercise
                of Stock Options
            10,000Eleanor
                Macdonald
            Feb
                - 05
            5
            1
            Exercise
                of Stock Options
            25,000Wayne
                Neuls
            Feb
                - 05
            5
            1
            Exercise
                of Stock Options
            25,000Louis
                Nuccio
            Feb
                - 05
            5
            1
            Exercise
                of Stock Options
            50,000Jack
                Tull
            Feb
                - 05
            5
            1
            Exercise
                of Stock Options
            10,000David
                A. Loppert
            Mar
                - 05
            5
            1
            Exercise
                of Stock Options
            1,100,000David
                Rubin
            Aug
                - 05
            5
            1
            Exercise
                of Stock Options
            6,666Dominick
                & Dominick
            Mar
                - 05
            6
            1
            Exercise
                of Stock Warrants
            400,000Paul
                Lee Newman
            Mar
                - 05
            6
            1
            Exercise
                of Stock Warrants
            100,000Bismark
                Intervest
            Apr
                - 05
            6
            1
            Exercise
                of Stock Warrants
            183,333Barron
                Partners
            Apr
                - 05
            6
            1
            Exercise
                of Stock Warrants
            550,000Alan
                Burger and Dana Burger, Joint Tenants
            Dec
                - 05
            7
            2
            Shares
                Issued for Services
            51,375Duncan
                J. Farmer
            Dec
                - 05
            7
            1
            Shares
                Issued for Services
            34,250Michael
                Sheerr
            Jan
                - 06
            5
            1
            Exercise
                of Stock Options
            100,000John
                W. Heilshorn
            Feb
                - 06
            7
            1
            Shares
                Issued for Services
            24,000Keith
                L. Lippert
            Feb
                - 06
            7
            1
            Shares
                Issued for Services
            24,000Whitmer
                & Worrall, LLC
            Mar
                - 06
            7
            1
            Shares
                Issued for Services
            40,540Michael
                Sheerr
            Mar
                - 06
            5
            1
            Exercise
                of Stock Options
            250,000Joel
                Owens
            Jun
                - 06
            8
            1
            Acquisition
            2,063,545




1.
            
            Represents
                shares issued in a Confidential Private Placement. The offering closed
                on
                July 18, 2003. 1,354,586 shares were sold at $.35 per share. Officers
                and
                directors (including their children) purchased 207,200 shares, or
                15.3% of
                the total shares sold.2.
            
            Represents
                shares issued in a Confidential Private Placement. The offering closed
                on
                September 2, 2003. The offering was for 20 units at a price of $10,000
                per
                Unit. Each Unit consisted of (i) 10,000 shares of common stock and
                warrants to purchase 10,000 shares of common stock, exercisable for
                a
                period of three years at a price of $1.00 per share.3.
            
            Represents
                an aggregate of 6,000,000 shares of our own common stock sold to
                6
                investors for a total of $3,600,000, or $.60 per share, which transaction
                was exempt from registration pursuant to Rule 506 of Regulation D
                promulgated under the Securities Act. The Investors were either accredited
                investors or sophisticated investors, and the total offering was
                less than
                10 non-accredited investors. There was no general solicitation or
                advertising for the sale of these shares, and the investors had access
                to
                or were provided with relevant financial and other information relating
                to
                us.4.
            
            Represents
                shares used in connection with the acquisition of Qualtech International
                Corporation and Affiliate, valued at $1.66 per share, which transaction
                was exempt from registration pursuant to Section 4(2) of the
                Act.5.
            
            Represents
                shares issued in connection with the exercise of common stock
                options.6.
            
            Represents
                shares issued in connection with the exercise of common stock
                warrants.7.
            
            Represents
                shares issued for services rendered.8.
            
            Represents
                shares used in connection with the payment of additional merger
                consideration that was due in conjunction with the acquisition of
                Qualtech
                International Corporation and Affiliate, valued at $1.66 per share.




15


**Item
      6.**  **Management’s
      Discussion And Analysis of Financial Condition and Results of
      Operations**




The
      following discussion should be read in conjunction with our audited Financial
      Statements and Notes thereto included herein.




Certain
      statements in this Report constitute “forward-looking statements” within the
      meaning of Section 27A of the Securities Act of 1933, Section 21E of the
      Securities Exchange Act of 1934 and the Private Securities Litigation Reform
      Act
      of 1995. We intend that such forward-looking statements be subject to the safe
      harbors created thereby.




All
      such
      forward-looking information involves risks and uncertainties and may be affected
      by many factors, some of which are beyond our control. These factors
      include:


·
            Our
                growth strategies.


·
            Anticipated
                trends in our business and
                demographics.


·
            Our
                ability to successfully integrate the business operations of recently
                acquired companies; and ·
            Regulatory, competitive or other economic
              influences.




Forward-looking
      statements involve known and unknown risks, uncertainties and other factors
      which may cause our actual results, performance or achievements to be materially
      different from any future results, performance or achievements expressed or
      implied by such forward-looking statements. Such factors include, among others,
      the following: our continued ability to sustain our growth through continuing
      vendor relationships; the successful consummation and integration of future
      acquisitions; the ability to hire and retain key personnel; the continued
      development of our technical, manufacturing, sales, marketing and management
      capabilities; relationships with and dependence on third-party suppliers;
      anticipated competition; uncertainties relating to economic conditions where
      we
      operate; uncertainties relating to government and regulatory policies;
      uncertainties relating to customer plans and commitments; rapid technological
      developments and obsolescence in the products we sell and the industries in
      which we operate and compete; existing and potential performance issues with
      suppliers and customers; governmental export and import policies; global trade
      policies; worldwide political stability and economic growth; the highly
      competitive environment in which we operate; potential entry of new,
      well-capitalized competitors into our markets; and changes in our capital
      structure and cost of capital. The words “believe”, “expect”, “anticipate”,
“intend” and “plan” and similar expressions identify forward-looking statements.
      Readers are cautioned not to place undue reliance on these forward-looking
      statements, which speak only as of the date the statement was made.




**Overview**




We
      are a
      technology services company. Our Data Security and Compliance services as well
      as our Data Center Hardware and Data Center Maintenance services are geared
      towards both the users of business-computing hardware (desktops, laptops,
      related peripherals and servers) as well as the users of enterprise-class
      hardware (mainframes, midrange processors, large storage, controllers, etc.).
      Our Data Security and Compliance services offer a variety of solutions to
      companies whose business computing technologies (desktops, laptops, printers,
      and servers) have come to the end of their life cycle. These services include
      data erasure to Department of Defense standards for hard drives, asset
      auditing/life cycle management which allows customers to minimize their overall
      Information Technology (IT) expenditure and maximize their return on investment,
      IT asset remarketing for IT assets with market value and environmental
      compliance (proper recycling or safe disposal) for IT assets. These services
      can
      be custom tailored to meet our customer's needs and implemented at QSGI
      facilities or one client location or at multiple client-site locations, through
      the use of one of our client-site solutions including our mobile audit and
      erasure truck and our client suitcase server.




16




We
      are a
      leading reseller of refurbished enterprise-class hardware and associated
      peripheral products to companies around the world. We remarket refurbished
      IBM
      mainframe processors, IBM midrange processors and associated peripheral products
      including tape and disk products and connectivity products.


We
      also
      provide hardware maintenance services for enterprise-class hardware and
      associated peripheral products and Data Center consulting to companies
      throughout the United States.







**Results
      Of Operations**




The
      following table sets forth, for the periods indicated below, the relationships
      to total revenue of line items in our statements of operations for the years
      ended December 31, 2006 and 2005.




Year
                Ended
            Year
                EndedDecember
                31, 2006
            December
                31, 2005**%**
            **%**Product
                Revenue
            88.6
            90.9Service
                Revenue
            11.4
            9.1Total
                Revenue
            100.0
            100.0Cost
                of Products Sold
            74.9
            76.0Cost
                of Services Sold
            3.9
            3.4Cost
                of sales
            78.8
            79.4Gross
                profit
            21.2
            20.6Selling,
                general and administrative
              expenses
            20.8
            24.0Depreciation
                and amortization
            1.5
            1.8Interest
                expense
            0.5
            0.4Income
                (loss) before provision (benefit)
              for
                income taxes
            (1.6)
            (5.6)Provision
                (benefit) for income taxes
            (0.5)
            (2.1)Net
                income (loss)
            (1.1)
            (3.5)




***Year
      Ended December 31, 2006 Compared to Year Ended December 31,
      2005***




Revenue
      for the year ended December 31, 2006 was $46,408,917 compared to revenue of
      $36,386,138 for the year ended December 31, 2005, a $10,022,779 increase, or
      27.5%. The increase was the result of organic growth. Revenues increased as
      we
      were able to find new sources of product and increased our purchases from our
      suppliers. This made more products available for sale as we increased our sales
      staff to help increase our market penetration.




Our
      revenues categorized by products and services are as follows:


Year
                Ended
            Year
                EndedDecember
                31, 2006
            December
                31, 2005RevenueProducts
            $
                41,111,420
            $
                33,085,383Services
            5,297,497
            3,300,755Total
                Revenue
            $
                46,408,917
            $
                36,386,138




17


Our
      revenue by geographic segment is as follows:




**Years
                Ended December 31,**
            **2006**
            **%**
            **2005**
            %
            Change
            %
                ChangeUnited
                States
            
            $40,024,087
            86%
            $33,893,593
            93%
            $6,130,494
            18%Asia
            
            1,824,038
            4%
            422,870
            1%
            1,401,168
            331%Europe
            
            219,608
            1%
            589,690
            2%
            (370,082)
            (63)%Africa
            
            602,447
            1%
            42,275
            --
            560,172
            1,325%United
                Kingdom
            
            935,473
            2%
            188,067
            --
            747,406
            397%Canada
            
            324,056
            1%
            203,055
            1%
            121,001
            60%Middle
                East
            
            1,823,709
            4%
            --
            --
            1,823,709
            --Australia
            
            12,825
            --
            --
            --
            12,825
            --South
                America
            
            642,674
            1%
            1,046,588
            3%
            (403,914)
            (39)%Total
            
            $46,408,917
            100%
            $36,386,138
            100%
            $10,022,779
            28%




We
      operate primarily in the United States and have minimal assets in foreign
      countries. However, we sell to customers in foreign countries. For the years
      ended December 31, 2006 and 2005, export sales comprised approximately 14%
      and
      7% of revenue, respectively. All of our purchases and sales are denominated
      in
      US dollars, and we recorded no foreign currency transaction gains or losses
      during any period. We have a small call center in India where we recorded a
      small currency loss in our selling, general and administrative
      expenses.




Gross
      profit for the year ended December 31, 2006 was $9,860,403 compared to a gross
      profit of $7,499,969 for the year ended December 31, 2005, a $2,360,434
      increase, or 31.5%. Gross margin was 21.2% for the year ended December 31,
      2006
      compared to 20.6% for the year ended December 31, 2005. Gross profit increased
      due to organic growth and our ability to hold down our semi-fixed cost of goods
      sold.




The
      overall management of computer equipment through out its life cycle represents
      a
      growing burden on companies. The continual growth of liability concerns
      associated with IT assets and the compliance with relatively new government
      legislation is what is going to have the biggest impact on the Company’s future
      revenues. Our business has been built to keep companies in compliance with
      government legislation whether it is HIPAA, Sarbanes-Oxley, the FACT Act,
      Gramm-Leach-Bliley, the Patriot Act or federal and state EPA regulations. As
      increasing numbers of computers are replaced or become obsolete, there is a
      greater source of computer equipment that is available for resale and a
      potentially greater source of customers needing our services.




Selling,
      general and administrative expenses for the year ended December 31, 2006, were
      $9,663,812 compared to selling, general and administrative expenses of
      $8,731,946 for the year ended December 31, 2005, a $931,866 increase, or 10.7%.
      Selling, general and administrative expense increased as a result of opening
      a
      sales office in India, and an increase in the reserve for doubtful accounts.




Depreciation
      and amortization for the year ended December 31, 2006, was $685,216 compared
      to
      depreciation and amortization of $634,014 for the year ended December 31, 2005,
      a $51,202 increase, or 8.1%. This increase was the result of one full year
      of
      depreciation for fixed asset acquisitions and leasehold improvements that
      occurred throughout 2005 and new additions purchased in 2006.




Interest
      expense for the year ended December 31, 2006, was $238,985 compared to interest
      expense of $160,441 for the year ended December 31, 2005, a $78,544 increase,
      or
      49.0%, commensurate with the increase in the Company’s borrowings and increased
      interest rates in 2006.




The
      Company recorded a federal tax benefit for the years ended December 31, 2006
      and
      2005. This benefit was reduced by estimated state tax obligations in
      jurisdictions where the Company cannot file a consolidated income tax return.






18





**Segments**





Our
      company operates in three segments that clearly focus our services into
      easy-to-understand categories for our target audiences:





**Data
      Security & Compliance**





We
      provide data security and regulatory compliance services for end-of-life
      business-computing Information Technology (IT) assets. We offer a variety of
      solutions to companies whose business computing technologies (desktops, laptops,
      printers and servers) have come to the end of their life cycle. These services
      include:


-
      Data
      erasure to Department Of Defense standards for hard drives


-
      Asset
      Auditing/Life Cycle Management which allows customers to minimize their overall
      IT expenditure and maximize their return on investment.


-
      IT
      asset remarketing for IT assets with market value


-
      Environmental compliance (proper recycling or safe disposal) for IT
      assets





These
      services can be custom tailored to meet our customer’s needs and implemented at
      QSGI facilities or one client location or at multiple client-site locations,
      through the use of one of our client-site solutions including our mobile audit
      and erasure truck and our client suitcase server.





**Data
      Center Hardware**





We
      are a
      leading reseller of refurbished enterprise-class hardware and associated
      peripheral products to companies around the world. We remarket refurbished
      IBM
      mainframe processors, IBM midrange processors and associated peripherals
      including tape and disk products and connectivity products.





**Data
      Center Maintenance**





We
      provide hardware maintenance services on enterprise-class hardware and
      associated peripheral products and Data Center consulting to companies
      throughout the United States.





Across
      all three segments, we purchase excess, used, off-lease and refurbished hardware
      from a variety of sources including Fortune 1000 companies, as well as leasing
      and finance companies.





19


**Data
      Security & Compliance Segment**





Year
                Ended
            
            Year
                EndedDecember
                31, 2006
            
            December
                31, 2005Revenue
            $
                22,013,739
            
            $
                14,922,002Gross
                Profit
            2,847,658
            
            1,362,219Selling,
                General and Administration
            5,146,509
            
            4,793,571Depreciation
                and Amortization
            225,516
            
            186,763Loss
                Before Benefitfor
                Income Taxes
            (2,763,369)
            
            (3,772,488)Segment
                Assets
            8,879,411
            
            6,841,435Goodwill
            -
            
            -Expenditures
                for Property andEquipment
            127,087
            
            285,694




Revenue
      for the year ended December 31, 2006 was $22,013,739 compared to revenue of
      $14,922,002 for the year ended December 31, 2005, a $7,091,737 increase or
      47.5%. Revenues increased as a result of a substantial increase in our wholesale
      remarketing revenue because we were able to find new sources of product, which
      made more products available for sale. We also had an increase in the number
      of
      new and existing corporate customers utilizing our full suite of services.
      In
      the fourth quarter of 2004, we made a critical decision not to remarket
      wholesale IT equipment for clients that would not ensure that the hard drives
      they were providing us were properly erased. Although this decision impacted
      our
      data security and compliance business in the beginning of 2005, we were
      determined that the best approach to this situation was to educate our clients
      about the importance of erasing hard drives. They are now either contracting
      with us or are providing these services internally. As a result, during the
      third quarter of 2005, we were able to resume our wholesale remarketing service
      for some of those clients. This had a full year impact on revenues in
      2006.




Gross
      profit for the year ended December 31, 2006 was $2,847,658 compared to gross
      profit of $1,362,219 for the year ended December 31, 2005, a $1,485,439 increase
      or 109.0%. Gross margin for the year ended December 31, 2006 was 12.9% compared
      to 9.1% for the year ended December 31, 2005. The improvement in our gross
      profit and gross margin reflects both an increase in our wholesale re-marketing
      revenues, while holding down our of semi-fixed cost of goods sold, as well
      as
      the addition of corporate customers utilizing our full suite of higher margin
      data security services.




Selling,
      general and administrative expense for the year ended December 31, 2006 was
      $5,146,509 compared to selling, general and administrative expense of $4,793,571
      for the year ended December 31, 2005, a $352,938 increase or 7.4%. Selling,
      general and administrative expense increased mostly as a result of a one time
      increase in our allowance for doubtful accounts taken in the first quarter
      of
      2006 whereby we took a charge of $349,000 from a single customer and against
      whom QSGI is pursuing recourse, an increase in payroll and related expenses,
      an
      increase in consulting and directors fees, an increase in bank and credit card
      fees offset by a reduction in legal and professional fees and an increase in
      amounts charged to other subsidiaries to offset corporate overhead.




Depreciation
      for the year ended December 31, 2006 was $225,516 compared to depreciation
      of
      $186,763 for the year ended December 31, 2005, a $38,753 increase or 20.7%.
      This
      was the result of one full year of depreciation for fixed asset acquisitions
      that occurred during 2005 and a portion of the year for 2006.





20


**Data
      Center Hardware Segment**





Year
                Ended
            
            Year
                EndedDecember
                31, 2006
            
            December
                31, 2005Revenue
            $
                20,035,133
            
            $
                19,790,233Gross
                Profit
            3,752,742
            
            4,057,775Selling,
                General and Administration
            2,580,299
            
            2,601,995Depreciation
                and Amortization
            397,358
            
            385,820Income
                Before Provisionfor
                Income Taxes
            775,849
            
            1,063,892Segment
                Assets
            12,669,721
            
            10,319,668Goodwill
            5,154,782
            
            2,957,193Expenditures
                for Property andEquipment
            16,564
            
            62,842




Revenue
      for the year ended December 31, 2006 was $20,035,133 compared to revenue of
      $19,790,233 for the year ended December 31, 2005, a $244,900 increase, or 1.2%.
      Hardware equipment tends to be a bigger ticket item and may be subject to the
      uneven nature of the sales cycle and the timing of shipments. This segment’s
      revenue growth has benefited from the strength of a few substantial hardware
      sales to existing data center hardware and data center maintenance clients.




Gross
      profit for the year ended December 31, 2006 was $3,752,742 compared to gross
      profit of $4,057,775 for the year ended December 31, 2005, a $305,033 decrease,
      or 7.5%. Gross margin in our Data Center Hardware segment for the year ended
      December 31, 2006 was 18.7% of revenue compared to 20.5% of revenue for the
      year
      ended December 31, 2005. Gross profit and margins decreased due to the fact
      that
      IBM was in the middle of a platform upgrade which put downward pressure on
      our
      margins even as we increased revenues.




Selling,
      general and administrative expenses for the year ended December 31, 2006 were
      $2,580,299 compared to selling, general and administrative expenses of
      $2,601,995 for the year ended December 31, 2005, a $21,696 decrease, or 0.8%.
      The decrease was the result of a strict cost containment policy instituted
      at
      the beginning of 2006.




Depreciation
      and amortization for the year ended December 31, 2006 was $397,358 compared
      to
      depreciation and amortization of $385,820 for the year ended December 31, 2005,
      an $11,538 increase, or 3.0%. This was the result of one full year of
      depreciation for fixed asset acquisitions that occurred during 2005 and a
      portion of the year for 2006.





**Data
      Center Maintenance Segment**





Year
                Ended
            
            Year
                EndedDecember
                31, 2006
            
            December
                31, 2005Revenue
            $
                4,847,885
            
            $
                3,096,222Gross
                Profit
            3,260,003
            
            2,079,974Selling,
                General and Administration
            1,937,004
            
            1,336,380Depreciation
                and Amortization
            62,342
            
            61,431Income
                Before Provisionfor
                Income Taxes
            1,259,910
            
            682,164Segment
                Assets
            2,629,689
            
            1,249,236Goodwill
            1,489,621
            
            255,121Expenditures
                for Property andEquipment
            10,077
            
            3,941





21




Revenue
      for the year ended December 31, 2006 was $4,847,885 compared to revenue of
      $3,096,222 for the year ended December 31, 2005, a $1,751,663 increase, or
      56.6%. The increase was the result of signing additional service contracts
      with
      new and existing customers this year as well as new contracts that were signed
      last year. These contracts are generally one to three years terms.




Gross
      profit for the year ended December 31, 2006 was $3,260,003 compared to gross
      profit of $2,079,974 for the year ended December 31, 2005, a $1,180,029
      increase, or 56.7%. Gross margin in our Data Center Maintenance segment for
      the
      year ended December 31, 2006 was 67.2% of revenue compared to 67.2% of revenue
      for the year ended December 31, 2005. Gross profit increased as a result of
      the
      increase in revenues.




Selling,
      general and administrative expenses for the year ended December 31, 2006 were
      $1,937,004 compared to selling, general and administrative expenses of
      $1,336,380 for the year ended December 31, 2005, a $600,624 increase or
      decrease, or 44.9%. This increase was mainly the result of additional personnel
      and compensation, increased insurance expense as revenues and personnel
      increased and an increase in the amount charged for corporate overhead
      allocation.




Depreciation
      and amortization for the year ended December 31, 2006 was $62,342 compared
      to
      depreciation and amortization of $61,431 for the year ended December 31, 2005,
      a
      $911 increase, or 1.5%. This was the result of one full year of depreciation
      for
      fixed asset acquisitions that occurred during 2005 and a portion of the year
      for
      2006.




***Liquidity
      and Capital Resources*** ******




Our
      current ratios at December 31, 2006 and December 31, 2005 were 2.1 to 1 and
      1.7
      to 1, respectively. Working capital at December 31, 2006 was $7,539,917 compared
      to $4,858,852 at December 31, 2005. Working capital increased primarily from
      the
      proceeds received from the issuance of redeemable preferred stock, the exercise
      of stock options, and net amounts borrowed under revolving lines of credit.
      This
      amount was reduced by financing the operations of the company.




Net
      cash
      used in operating activities for the year ended December 31, 2006 was $1,583,230
      compared to $5,186,645 of cash used in operating activities for the year ended
      December 31, 2005. Cash used in operating activities for the year ended December
      31, 2006 was primarily a result of an increase in accounts receivable,
      inventories, deferred taxes and the net loss. This was offset by an increase
      in
      accounts payable and accrued expenses, common stock issued for services, and
      depreciation and amortization. Cash used in operating activities for the year
      ended December 31, 2005 was primarily a result of an increase in accounts
      receivable, inventories, deferred taxes and the net loss. This was offset by
      an
      increase in payables and accrued expenses, depreciation and amortization, and
      stock issued for services.




Net
      cash
      used in investing activities for the years ended December 31, 2006 and 2005
      was
      $145,454 and $438,997, respectively. For the year ended December 31, 2006,
      cash
      was used for the purchase of property and equipment. For the year ended December
      31, 2005, cash was used for the purchase of property and equipment and
      additional payment due for the 2004 acquisition.




Net
      cash
      provided by financing activities for the years ended December 31, 2006 and
      2005
      was $2,207,838 and $4,934,497. For the year ended December 31, 2006, net cash
      was provided for by proceeds from the issuance of redeemable convertible
      preferred stock, and net amounts borrowed under revolving lines of credit,
      reduced by preferred stock dividends. For the year ended December 31, 2005,
      net
      cash was provided for by proceeds from the issuance of redeemable preferred
      stock, the exercise of stock options and warrants, net amounts borrowed under
      revolving lines of credit and was reduced to pay off notes payable and to
      repurchase stock warrants.








22


Since
      the
      2004 acquisition, we have invested in strengthening our infrastructure and
      have
      used cash to increase inventory to a level necessary to support our growth.
      Our
      accounts receivable increased as a result of strong sales in December 2006.
      In
      January 2007, we completed the financing of a new $7.5 million working capital
      facility with Wells Fargo Bank, which increased and replaced a similar based
      line of credit of $4.25 million and greatly improved our working capital
      flexibility. The new revolving line of credit agreement provides for borrowings
      limited to the lesser of $7,500,000 or the borrowing base of 85% of eligible
      accounts receivable plus 45% of eligible inventory, with eligible inventory
      not
      to exceed $3,000,000. Interest on this loan is payable monthly at the prime
      rate, with all principal and interest due January 24, 2010. The new revolving
      line-of-credit agreement contains certain financial covenants, including net
      income requirements as follows:




Period
                  ending
              Quarterly
                  net income (loss)
              Year
                  to date net income (loss)March
                  31, 2007
              $(250,000)
              $(250,000)June
                  30, 2007
              500,000
              250,000September
                  30, 2007
              150,000
              400,000December
                  31, 2007
              400,000
              800,000March
                  31, 2008
              100,000
              100,000June
                  30, 2008
              200,000
              300,000September
                  30, 2008
              200,000
              500,000December
                  31, 2008
              300,000
              800,000March
                  31, 2009
              100,000
              100,000June
                  30, 2009
              200,000
              300,000September
                  30, 2009
              200,000
              500,000December
                  31, 2009
              300,000
              800,000




If
      the
      Company is unable to achieve these covenants on a quarterly basis, it will
      be
      considered to be in default of the line-of-credit. If the Company is in default,
      the lender has the right to terminate the agreement, causing all amounts to
      become immediately due and payable.




If
      the
      Company were to be in default under its line-of-credit agreement, it could
      pursue certain options, such as negotiating new terms with the financial
      institution. However, there can be no guarantee that the Company would be able
      to negotiate new agreements. Additionally, if the Company were to be successful
      in negotiating new agreements, they could be on terms that are less favorable
      to
      the Company than the current line-of-credit agreement.




We
      believe that the anticipated cash flow from operations and current financing
      arrangements together with anticipated exercise of stock options and warrants
      in
      2007 will be sufficient to meet our cash requirements for at least the next
      12
      months. However, we may need to raise additional funds to finance unanticipated
      working capital requirements or to acquire complementary businesses although
      we
      have not identified any specific acquisition candidates.




23




We
      do not
      have any material commitments for capital expenditures nor do we expect to
      incur
      any material commitments for capital expenses during 2007.




We
      did
      not have any significant elements of income or loss not arising from continuing
      operations in 2006 or 2005 and do not expect any in 2007. While our business
      is
      marginally seasonal, we do not expect this seasonality to have a material
      adverse affect on our results of operations or cash flows.




On
      June
      22, 2006, under the terms of the acquisition agreement, as amended, with
      Qualtech International Corporation and its affiliate, Qualtech Services Group,
      Inc. that was completed on May 28, 2004, additional merger consideration was
      paid to the selling shareholders. The selling shareholders were entitled to
      receive additional merger consideration in the form of restricted shares of
      the
      Company. 2,063,545 shares were issued at a value of approximately $1.66 per
      share resulting in additional goodwill in the amount of $3,432,089.




***Off-Balance
      Sheet Arrangements*** ******




The
      company does not have any off-balance sheet arrangements.




**Factors
      Affecting Future Operating Results**




You
      should carefully consider the following risk factors, together with all other
      information contained or incorporated by reference in this filing, before you
      decide to purchase shares of our stock. These factors could cause our future
      results to differ materially from those expressed in or implied by
      forward-looking statements made by us. Additional risks and uncertainties not
      presently known to us or that we currently deem immaterial may also harm our
      business. The trading price of our common stock could decline due to any of
      these risks, and you may lose all or part of your investment.




***Uncertainty
      Of Future Financial Results***




Our
      future financial results are uncertain. There can be no assurance that we will
      be profitable, and we may incur losses in the foreseeable future. Achieving
      and
      sustaining profitability depends upon many factors, including our ability to
      raise capital when needed, the success of our various marketing programs, and
      the maintenance or reduction of expense levels.




***Fluctuations
      In Future Quarterly Results***




We
      have
      been in business since October 2001 and have only twenty one quarters of
      historic quarterly operating results, only five of which have been profitable.
      Our quarterly operating results may fluctuate based on how well we manage our
      business. Some of the factors that may affect how well we manage our business
      include the timing of our delivery of significant orders; our ability to
      engineer customer solutions in a timely, cost effective manner; our ability
      to
      structure our organization to enable achievement of our operating objectives;
      our ability to meet the needs of our customers and markets; the ability to
      deliver, in a timely fashion, products for which we have received orders; the
      length of the sales cycle; the demand for products and services we offer; the
      introduction or announcements by computer manufacturers relating to the
      remarketing of new and used equipment; the hiring and training of additional
      personnel; as well as general business conditions. If we fail to effectively
      manage our business, this could adversely affect our results of
      operations.




We
      expect
      that the size and timing of our sales transactions may vary substantially from
      quarter to quarter, and we expect such variations to continue in future periods,
      including the possibility of losses in one or more fiscal quarters. These
      fluctuations may be caused by delays in shipping certain computer systems for
      which we receive orders that we expect to deliver during that quarter. In
      addition, our collection periods may fluctuate due to periodic shortages of
      goods available for shipment, which may result in the delay of payment from
      customers who will not pay until their entire order is shipped. Accordingly,
      it
      is likely that in one or more future fiscal quarters, our operating results
      could be below investors’ expectations and, as a result, any future public
      offering of shares of our Common Stock could be materially adversely affected.






24


***Industry
      cycles may strain our management and resources***





Cycles
      of
      growth and contraction in our industry may strain our management and resources.
      To manage these industry cycles effectively, we must: improve operational and
      financial systems; train and manage our employee base; successfully integrate
      operations and employees of businesses we acquire or have acquired; attract,
      develop, motivate and retain qualified personnel with relevant experience;
      and
      adjust spending levels according to prevailing market conditions. If we cannot
      manage industry cycles effectively, our business could be seriously harmed.




***We
      Have Limited Principal Markets And Customers; We Have Significant Dependence
      On
      Major Customers; There Is A Risk Of Industry
      Concentration***




We
      operate primarily in the United States and have minimal assets in foreign
      countries. We sell and deliver computer systems, peripheral devices and parts
      to
      more than 300 customers throughout the United States and on 6 continents
      worldwide. For the years ended December 31, 2006 and 2005, our top ten customers
      accounted for approximately 44% and 37% of our total revenues, respectively.
      In
      2005, one of those customers was Keystone Memory Group, a “related party” for
      accounting purposes. We cannot be certain that customers that have accounted
      for
      significant revenue in past periods will continue to generate revenue. As a
      result of this concentration of our customers, our results of operations could
      be negatively affected if any of the following occurs: one or more of our
      customers becomes insolvent or goes out of business; one or more of our key
      customers significantly reduces, delays or cancels orders; or one or more of
      our
      significant customers selects products or services from one of our
      competitors.




Due
      to
      our acquisition, our customer base has broadened significantly and we therefore
      anticipate being less dependent on a relatively small number of customers to
      generate revenue. However, as revenue mix fluctuates from quarter to quarter,
      we
      may become more dependent on a small number of customers for a significant
      portion of our revenue in a particular quarter, the loss of which could
      adversely affect our operation results.




With
      the
      exception of several of our maintenance contracts and data security contracts,
      we do not have any exclusive long-term arrangements with our customers for
      the
      continued sales of our products or services. Our failure to acquire additional
      significant or principal customers or to maintain our relationships with our
      existing principal customers could have a material adverse effect on our results
      of operations and cash flows.




For
      the
      years ended December 31, 2006 and 2005, primarily all of our sales of computer
      systems, peripherals and parts were to remarketers based in the United States
      or
      brokers based both in and out of the United States for whom we directly exported
      product. For the years ended December 31, 2006 and 2005, export sales comprised
      14% and 7% of revenue, respectively. All of our purchases and sales are
      denominated in US dollars and we recorded no foreign currency transaction gains
      or losses during any period. We have a small call center in India where we
      recorded a small currency loss in our selling, general and administrative
      expenses.






25




Although
      we are striving to broaden our market focus to include sales to other markets,
      both nationally and internationally, in the immediate future we expect that
      we
      will continue to derive a substantial percentage of our sales of product to
      such
      brokers and remarketers. Accordingly, unfavorable economic conditions or factors
      that relate to these industries, particularly any such conditions that might
      result in reductions in capital expenditures or changes in such companies'
      information processing system requirements, could have a material adverse effect
      on our results of operations.




***We
      Rely On Merchandise Vendors As Sources For Our
      Products***




The
      availability of off-lease and excess inventory computer equipment is
      unpredictable. We have no long-term arrangements with our vendors that assure
      the availability of equipment. We purchase equipment from more than 25 different
      vendors, and we have no formal commitments with or from any of them. We cannot
      assure you that our current vendors will continue to sell equipment to us as
      they have in the past, or that we will be able to establish new vendor
      relationships that ensure equipment will be available to us in sufficient
      quantities and at favorable prices. If we are unable to obtain sufficient
      quantities of equipment at favorable prices, our business will be adversely
      affected. In addition, we may become obligated to deliver specified types of
      computer equipment in a short time period and, in some cases, at specified
      prices. Because we have no formal relationships with vendors, we may not be
      able
      to obtain the required equipment in sufficient quantities in a timely manner,
      which could adversely affect our ability to fulfill these obligations.




***We
      Are Subject To Risks That Our Inventory May Decline In Value Before We Sell
      It
      Or That We May Not Be Able To Sell The Inventory At The Prices We
      Anticipate***




We
      purchase and warehouse inventory, most of which is “as-is” or excess inventory
      of computer equipment. As a result, we assume inventory risks and price erosion
      risks for these products. These risks are especially significant because
      computer equipment generally is characterized by rapid technological change
      and
      obsolescence. These changes affect the market for refurbished or excess
      inventory equipment. Our success will depend on our ability to purchase
      inventory at attractive prices relative to its resale value and our ability
      to
      turn our inventory rapidly through sales. If we pay too much or hold inventory
      too long, we may be forced to sell our inventory at a discount or at a loss
      or
      write down its value, and our business could be materially adversely
      affected.




***Declining
      Prices For New Computer Equipment Could Reduce Demand For Our
      Products***




The
      cost
      of new computer equipment has declined dramatically in recent years. As the
      price of new computer products declines, consumers may be less likely to
      purchase refurbished computer equipment unless there is a substantial discount
      to the price of the new equipment. Accordingly, if we were to sell “as-is” or
      refurbished equipment directly to end users, we would have to offer the products
      at a substantial discount to the price of new products. As prices of new
      products continue to decrease, our revenue, profit margins and earnings could
      be
      adversely affected. There can be no assurance that we will be able to maintain
      a
      sufficient pricing differential between new products and our “as-is” or
      refurbished products to avoid adversely affecting our revenues, profit margins
      and earnings.






26




***If
      We Need Additional Financing For Unanticipated Working Capital Needs Or To
      Finance*** ***Acquisitions,
      We May Not Be Able To Obtain Such Capital, Which Could Adversely Affect Our
      Ability To Achieve Our Business Objectives***




We
      believe that cash that may be generated from operations, together with other
      available cash resources, will be sufficient to meet our cash requirements
      for
      at least the next 12 months. However, we may need to raise additional funds
      to
      finance unanticipated working capital requirements or acquire complementary
      businesses, although we have not identified any specific acquisition candidates.
      If funds are not available when required for our unanticipated working capital
      needs or other transactions, our ability to carry out our business plan could
      be
      adversely affected, and we may be required to scale back our growth and
      operations to reflect the extent of available funding.




***We
      have made acquisitions in the past and may make acquisitions in the future,
      if
      advisable, and these acquisitions involve numerous
      risks.***





Our
      growth depends upon market growth and our ability to enhance our existing
      products and services, and to introduce new products and services on a timely
      basis. One of the ways to accomplish this is through acquisitions. In 2004,
      we
      completed the acquisitions of Qualtech International Corporation and its
      affiliate Qualtech Services Group. Acquisitions involve numerous risks,
      including, but not limited to, the following:





·
            difficulty
                and increased costs in assimilating employees, including our possible
                inability to keep and retain key employees of the acquired
                business;


·
            disruption
                of our ongoing business;


·
            discovery
                of undisclosed liabilities of the acquired companies and legal disputes
                with founders or shareholders of acquired
                companies;


·
            inability
                to successfully incorporate acquired technology and operations into
                our
                business and maintain uniform standards, controls, policies, and
                procedures;


·
            inability
                to commercialize acquired technology;
                and


·
            the
                need to take impairment charges or write-downs with respect to acquired
                assets.





No
      assurance can be given that our prior acquisitions or our future acquisitions,
      if any, will be successful or provide the anticipated benefits, or that they
      will not adversely affect our business, operating results or financial
      condition. Failure to manage growth effectively and to successfully integrate
      acquisitions made by us could materially harm our business and operating
      results.




***If
      We Experience Problems In Our Distribution Operations, We Could Lose
      Customers***




In
      addition to product vendors, we depend on several other third parties over
      whom
      we have limited control, including, in particular, Federal Express, United
      Parcel Service and common carriers for delivery of products to and from our
      distribution facility and to our customers. We have no long-term relationships
      with any of those parties. We are therefore subject to risks, including risks
      of
      employee strikes and inclement weather, which could result in failures by such
      carriers to deliver products to our customers in a timely manner, which could
      damage our reputation and name.




***The
      Industry In Which We Compete In Is Highly Competitive***




We
      face
      competition in each area of our business, although in the Data Center Hardware
      Segment, there are no significant competitors. Some of our competitors have
      greater resources and a more established market position than we have. Our
      primary competitors include:






27




·
            major
                manufacturers of computer equipment such as, Dell Computer Corporation,
                Hewlett Packard and IBM, each of which offer “as-is”, refurbished and new
                equipment through their websites and direct e-mail broadcast
                campaigns;




·
            privately
                and publicly owned businesses such as Redemtech, Solectron and
                Spacefitters that offer asset management and end-of-life product
                refurbishment and remarketing services;




·
            traditional
                store-based computer retailers, such as Best Buy Co., Inc., Circuit
                City
                Stores, Inc., and CompUSA; and




·
            online
                competitors and auction sites, such as
                e-Bay




Some
      competitors have longer operating histories, larger customer or user bases,
      greater brand name recognition and significantly greater financial, marketing
      and other resources than we do. Some of these competitors already have an
      established brand name and can devote substantially more resources to increasing
      brand name recognition and product acquisition than we can. In addition, larger,
      well-established and well-financed entities may join with online competitors
      or
      computer manufacturers or suppliers as the use of the Internet and other online
      services increases. Our competitors may be able to secure products from vendors
      on more favorable terms, fulfill customer orders more efficiently or adopt
      more
      aggressive price or inventory availability policies than we can. Traditional
      store-based retailers also enable customers to see and test products in a manner
      that is not possible in the wholesale business. Our product offerings must
      compete with other new computer equipment and related products offered by our
      competitors. That competition may intensify if prices for new computers continue
      to decrease.




***No
      Dividends On Common Stock; Issuance Of Preferred
      Stock***




We
      do not
      have a history of paying dividends on our Common Stock, and there can be no
      assurance that dividends will be paid in the foreseeable future. We intend
      to
      use any earnings, which may be generated to finance the growth of our
      businesses. Our Board of Directors has the right to authorize the issuance
      of
      preferred stock, without further shareholder approval, the holders of which
      may
      have preferences over the holders of the Common Stock as to payment of
      dividends.




***Dependence
      On Key Individuals***




Our
      success depends to a significant extent upon the continued contributions of
      our
      key management, technical and sales personnel, many of who would be difficult
      to
      replace. The loss of one or more of these employees could harm our business.
      Although we have entered into a limited number of employment contracts with
      certain executive officers, we generally do not have employment contracts with
      our key employees. Our success also depends on our ability to identify, attract
      and retain qualified technical, sales, marketing, finance and managerial
      personnel. Competition for qualified personnel is particularly intense in our
      industry and in our location. This makes it difficult to retain our key
      personnel and to recruit highly qualified personnel. We have experienced, and
      may continue to experience, difficulty in hiring and retaining candidates with
      appropriate qualifications. To be successful, we need to hire candidates with
      appropriate qualifications and retain our key executives and
      employees.




We
      are
      organized with a small senior management team. If we were to lose the services
      of one of the following members of our management team, our overall operations
      could be adversely affected. We consider our key individuals to be:






28




**Name**
            **Position**Marc
                Sherman
            Chairman,
                Chief Executive Officer, DirectorSeth
                A. Grossman
            President
                , Chief Operating Officer, DirectorEdward
                L. Cummings
            Chief
                Financial Officer, Treasurer, DirectorJoel
                L. Owens
            Executive
                Vice President Data Center Hardware and Data Center Services
                GroupDavid
                M. Harris
            Vice
                President, Information Technology and
                Systems




***Anti-Takeover
      Provisions***




Certain
      provisions of our Amended and Restated Certificate of Incorporation, Amended
      and
      Restated By-laws and Delaware law may be deemed to have an anti-takeover effect.
      Our certificate of incorporation provides that our Board of Directors may issue
      additional shares of Common Stock or establish one or more classes or series
      of
      Preferred Stock with such designations, relative voting rights, dividend rates,
      liquidation and other rights, preferences and limitations that the Board of
      Directors fixes without stockholder approval. In addition, we are subject to
      the
      anti-takeover provisions of Section 203 of the Delaware General Corporation
      Law.
      In general, the statute prohibits a publicly held Delaware corporation from
      engaging in a "business combination" with an "interested stockholder" for a
      period of three years after the date of the transaction in which the person
      became an interested stockholder, unless the business combination is approved
      in
      a prescribed manner. Each of the foregoing provisions may have the effect of
      rendering more difficult, delaying, discouraging, preventing or rendering more
      costly an acquisition of the Company or a change in control of the
      Company.




**Critical
      Accounting Policies**




Management
      is responsible for the integrity of the financial information presented herein.
      The Company’s financial statements have been prepared in accordance with
      accounting principles generally accepted in the United States of America. Where
      necessary, they reflect estimates based on management’s judgment. When selecting
      or evaluating accounting alternatives, management focuses on those that produce
      from among the available alternatives information most useful for
      decision-making. Significant accounting policies that are important to the
      portrayal of the Company’s financial condition and results, which in some cases
      require management’s judgment, are summarized in the Notes to Financial
      Statements which are included herein in Item 7.




The
      Company believes that the critical accounting policies discussed below involve
      additional management judgment due to the sensitivity of the methods,
      assumptions and estimates necessary in determining the related asset, liability,
      revenue and expense amounts.




The
      Company recognizes revenue when it is realized or realizable and earned. The
      Company provides a limited “DOA Warranty” in connection with some of its product
      sales. DOA means “Dead On Arrival” and is a commonly used term in the computer
      industry. If provided to our customer, this warranty applies to used computers,
      disk drives, CD drives or DVD drives that do not power-up when they are received
      or, in some cases, for a period of up to 60 days from receipt and provides
      that
      the covered equipment can be returned for a full refund or replacement product,
      if available. The decision whether to provide a refund or replacement product
      is
      generally at our option, but in limited circumstances, it may be at the
      customer’s option. Based on an internal study by management, we determined that
      approximately 3% of Company’s sales that are covered under this warranty are
      returned to the Company. The Company has alternative methods to sell the
      returned equipment by tearing it down and selling the working components as
      parts and the non-working components to metal recyclers. The alternative sales
      methods are rarely below the original cost of the equipment. The Company has
      not
      had any significant differences for the years ended December 31, 2006 and 2005.
      Therefore, no warranty reserve has been recorded. Should a reserve be recorded,
      it would increase both cost of sales and accrued expenses. The Company has
      however set up a sales returns and allowances reserve of $18,000. This account
      is reviewed quarterly and any additional reserve would decrease sales and
      increase the reserve.




29




The
      Company provides estimated inventory allowances for excess, slow-moving and
      obsolete inventory as well as for inventory whose carrying value is in excess
      of
      net realizable value. These reserves are based on current assessments about
      future demands, market conditions and related management initiatives. Management
      continually monitors its inventory valuation, and makes an assessment of its
      inventory allowance on a quarterly basis. If market conditions and actual
      demands are less favorable than those projected by management, additional
      inventory write-downs may be required, which would be a decrease to our
      inventory balance and an increase to cost of sales.




The
      Company provides an estimated allowance for doubtful accounts and an allowance
      for sales returns. The allowance for doubtful accounts is based on management’s
      assessment about future collectibility of accounts receivable on an account
      by
      account basis, with a reserve set up accordingly. If conditions change,
      additional allowances may be required which would decrease our accounts
      receivable balance and increase our bad debt expense. The allowance for sales
      returns is based on historical data and management’s assessment of how much of a
      return of product is resalable. This allowance is reviewed on a quarterly basis
      and if required, an adjustment is made to increase or decrease the reserve
      and
      increase or decrease sales.




The
      Company accounts for stock-based employee compensation awards using a fair
      value
      method and records such expense in the consolidated financial statements in
      accordance with the provisions of the Statement of Financial Accounting
      Standards (SFAS) No. 123R, Share Based Payment that was issued by the FASB.




The
      Company in accordance with the SFAS No. 142, Goodwill and Other Intangible
      Assets performs impairment tests in the fourth quarter of each year. As of
      December 31, 2006 and 2005, the Company performed impairment tests and has
      determined that the carrying value of such assets were not impaired as of those
      dates.




Deferred
      tax assets and liabilities are recognized for the future tax consequences
      attributable to the differences between the financial statement carrying amounts
      of existing assets and liabilities and their respective tax bases. Deferred
      tax
      assets and liabilities are measured using enacted tax rates expected to apply
      to
      taxable income in the years in which those temporary differences are expected
      to
      be recovered or settled. The effect on deferred tax assets and liabilities
      of a
      change in tax rates is recognized in income in the period that includes the
      enactment date. A valuation allowance is provided against net deferred tax
      assets where the Company determines realization is not currently judged to
      be
      more likely than not.




**Impact
      Of Recently Issued Accounting Standards**





In
      December 2004, the FASB issued Statement of Financial Accounting Standards
      (SFAS) No. 123R, *Share-Based
      Payment.* SFAS No.
      123R requires measurement of all employee stock-based compensation awards using
      a fair value method and the recording of such expense in the consolidated
      financial statements. In addition, the adoption of SFAS No. 123R requires
      additional accounting related to the income tax effects and additional
      disclosure regarding the cash flow effects resulting from share-based payment
      arrangements. Effective January 1, 2006, the Company adopted SFAS No. 123R
      using
      the modified prospective method. On December 28, 2005, the Company’s board of
      directors approved a resolution that provides for the vesting on December 28,
      2005 of the majority of the Company’s outstanding and unvested stock options
      previously awarded to employees and directors. The purpose of accelerating
      the
      vesting of the employee’s and directors’ options was to enable the Company to
      avoid recognizing in its statement of operations compensation expense associated
      with the options in future periods. As a result of the acceleration, the Company
      expects to avoid recognition of up to approximately $493,000 after tax of
      compensation expense in its statement of operations over the course of the
      original vesting period, substantially all of which is expected to be avoided
      in
      2006 and 2007.





30


In
      September 2006, the Securities and Exchange Commission issued Staff Accounting
      Bulletin (“SAB”) No. 108, *Considering
      the Effects of Prior Year Misstatements when Quantifying Current Year
      Misstatements.* SAB
      No. 108 requires analysis of misstatements using both an income statement
      (rollover) approach and a balance sheet (iron curtain) approach in assessing
      materiality and provides for a one-time cumulative effect transition
      adjustment. SAB No. 108 is effective for fiscal years ending after November
      15, 2006. The adoption of SAB No. 108 did not have an impact on the company's
      financial position or results of operations.





In
      September 2006, the FASB issued SFAS No. 157, *Fair
      Value Measurements,* which
      defines fair value, establishes a framework for measuring fair value in
      generally accepted accounting principles, and expands disclosures about fair
      value measurements. SFAS No. 157 does not require any new fair value
      measurements, but provides guidance on how to measure fair value by providing
      a
      fair value hierarchy used to classify the source of the information. This
      statement is effective for the Company beginning January 1, 2008. The Company
      is
      currently assessing the potential impact that adoption of SFAS No. 157 will
      have on its financial statements.




In
      June
      2006, the FASB issued FIN No. 48, *Accounting
      for Uncertainty in Income Taxes - an interpretation of FASB Statement
      No. 109,* which
      clarifies the accounting for uncertainty in income taxes recognized in an
      enterprise’s financial statements in accordance with FASB Statement
      No. 109, *Accounting
      for Income Taxes.* The
      interpretation prescribes a recognition threshold and measurement attribute
      for
      the financial statement recognition and measurement of a tax position taken
      or
      expected to be taken in a tax return. FIN No. 48 requires recognition of
      tax benefits that satisfy a greater than 50% probability threshold. FIN
      No. 48 also provides guidance on derecognition, classification, interest
      and penalties, accounting in interim periods, disclosure, and transition. FIN
      No. 48 is effective for the Company beginning January 1, 2007. The Company
      is currently assessing the potential impact that adoption of FIN No. 48
      will have on its financial statements .




**Item
      7.**  **Financial
      Statements**




Our
      financial statements included in this Annual Report on Form 10-KSB are listed
      in
      Item 13 and begin immediately after Item 14 on pages F-1 through
      F-31.




**Item
      8.**  **Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure**




None







31






**Item
      8A.**  **Controls
      and procedures**




**Evaluation
      of Disclosure Controls and Procedures**





Our
      management, including our chief executive officer, president and our chief
      financial officer, has conducted an evaluation of the effectiveness of our
      disclosure controls and procedures (as defined in Rule 13a-15(e) under the
      Securities and Exchange Act of 1934) as of December 31, 2006. This evaluation
      was carried out under the supervision and with the participation of our
      management, including our chief executive officer, president and chief financial
      officer. Based upon that evaluation, our chief executive officer, president
      and
      our chief financial officer have concluded that our disclosure controls and
      procedures are effective for timely gathering, analyzing and disclosing the
      information we are required to disclose in our reports filed under the Exchange
      Act.




There
      were no changes in our internal control over financial reporting during the
      quarter ended December 31, 2006 that have materially affected, or are reasonably
      likely to materially affect, our internal control over financial
      reporting.





We
      are
      continuing to evaluate the employees involved and the control procedures in
      place as well as the costs and benefits of making changes in the number and
      duties of employees. We are also working to document controls this year and
      to
      identify items that might require remediation in connection with our compliance
      with Section 404 of the Sarbanes-Oxley Act of 2002.




**Part
      III**




**Item
      9.**  **Directors,
      Executive Officers, Promoters and Control Persons; Compliance with Section
      16(a)
      of the Exchange Act**




***AS
      of March 1, 2007, Our Directors and Executive Officers
      are:***




**Name**
            **Age**
            **Position**Marc
                Sherman
            43
            Chairman,
                Chief Executive Officer, DirectorSeth
                A. Grossman
            41
            President,
                Chief Operating Officer, DirectorEdward
                L. Cummings
            58
            Chief
                Financial Officer, Treasurer, DirectorDavid
                Harris
            44
            Vice
                President, Information Technology and SystemsR.
                Keith Elliott
            64
            DirectorRobert
                W. VanHellemont
            61
            DirectorGeoffrey
                A. Smith
            49
            DirectorJohn
                F. Cunningham
            63
            Director




*Marc
      Sherman* founded
      QSGI INC. in August 2001 and has served as Chairman and Chief Executive Officer
      since then. His term of office expires at the 2009 annual meeting. Mr. Sherman
      served as a director of and Chief Executive Officer of Intellesale, Inc. (and
      its predecessor, Universal Commodities Corp.), from December 1994 to July 2001,
      a company that purchased and sold large volumes of off-lease/off finance excess,
      used, refurbished and “as-is” computer equipment and related products and which
      provided technology asset management to companies wishing to maximize the value
      of their computer equipment coming to the end of its useful or book lives.
      Prior
      to 1994, Mr. Sherman served in key positions in various family businesses.
      Mr.
      Sherman has over fifteen years of experience in marketing, operations and
      executive management.




32




*Seth
      A. Grossman* was
      hired
      on March 14, 2005 as the President and Chief Operating Officer *.* He
      had ** joined
      the Board of Directors in November 2003. His term of office expires at the
      2007
      annual meeting. Mr. Grossman was the Executive Vice President and Chief
      Strategic Officer of ION Media Networks (AMEX:ION), formerly Paxson
      Communications Corporation. He joined ION Media Networks in 1995 as its Director
      of Finance, before assuming additional responsibilities as SVP of Investor
      Relations and Corporate Development and then Chief Financial Officer. Prior
      to
      his tenure at ION, Mr. Grossman was a Senior Associate with Houlihan, Lokey,
      Howard & Zukin, a specialty investment bank in New York where he
      concentrated on corporate finance, valuation advisory and restructuring. Mr.
      Grossman was also a partner with McFerren Holding Co., a Central and Eastern
      European privatization consulting firm. Mr. Grossman holds a BBA with
      distinction from the University of Michigan and an MBA from the Harvard Graduate
      School of Business Administration. He has previously served as a director on
      the
      Board of the Enterprise Development Corporation of South Florida, a
      not-for-profit technology enterprise development concern.




*Edward
      L. Cummings* co-founded QSGI INC. and has served as its Chief Financial Officer and Treasurer
      since inception. His term of office expires at the 2008 annual meeting. Mr.
      Cummings joined the Board of Directors of the Company in February 2004 to fill
      a
      vacancy. He served as Executive Vice President, Chief Financial Officer and
      Secretary of Intellesale, Inc. from July 1999 to February 2001. He joined its
      predecessor company Universal Commodities Corp. in October 1995 as controller
      and was elected to the board of directors in January 1997. From September 1994
      to October 1995 he owned TCC, Inc., an operator of several retail gift shops.
      From December 1981 to September 1994 he was Chief Financial Officer and
      Treasurer of Albert E. Price, Inc., a giftware import and export
      company.




*David
      M. Harris* joined
      QSGI INC. in May 2002 as Vice President, Information Technology and Systems.
      Mr.
      Harris is responsible for the development, implementation and maintenance of
      the
      Company’s information technology systems and processes. Prior to joining the
      Company, Mr. Harris was, from October 2001 to May 2002 a private consultant
      and,
      from April 1998 to October 2001, Network and Systems Administrator for
      Intellesale, Inc. Prior thereto, from 1984 to 1998 he held various positions
      as
      Network and Systems Administrator and Programmer for various companies.




*R.
      Keith Elliott* was
      appointed to the board of directors in January 2003 to fill a vacancy. His
      term
      of office expires at the 2007 annual meeting. Mr. Elliott is the retired
      chairman and chief executive officer of Hercules, Inc. From 1991 to April 2000,
      he served Hercules, Inc. as Senior Vice President and Chief Financial Officer;
      Executive Vice President and Chief Financial Officer; President and Chief
      Operating Officer; President and Chief Executive Officer; and Chairman of the
      Board of Directors. Hercules, Inc. is a multi-national specialty chemical
      manufacturer. Mr. Elliott is a member of the Board of Directors of Checkpoint
      Systems, Inc., a multi-national manufacturer of electronic labeling systems
      used
      in the retail industry to identify products and reduce theft, Wilmington Trust
      Company, which provides customized financial alternatives for wealth advisory
      clients, corporate clients, and regional banking clients,  and
      the
      Institute for Defense Analyses, a federally funded research and development
      company. Mr. Elliott serves as Chairman of the Compensation Committee and is
      a
      member of the Audit Committee of the Board of Directors. The Board of Directors
      has determined that Mr. Elliott is an Audit Committee Financial Expert, as
      that
      term is defined in the rules issued pursuant to the Sarbanes-Oxley Act of 2002.
      This designation does not impose any duties, obligations or liabilities that
      are
      greater than the duties, obligations and liabilities imposed by being a member
      of the audit committee or board of directors. The Board of Directors has also
      determined that Mr. Elliott is independent, as that term is defined under the
      enhanced independence standards for audit committee members in the Securities
      Exchange Act of 1934 and rules there under.




33




*Robert
      W. VanHellemont* was
      appointed to the Board of Directors in August 2004 to fill a vacancy. His term
      of office expires at the 2009 annual meeting. Mr. VanHellemont is the founder
      and chief executive officer of the Varilease companies. The Varilease companies
      are leading North American business equipment and financing providers, which
      have financed more than $2 billion in assets worldwide. Mr. VanHellemont founded
      Varilease Corp. in 1987 and founded Varilease Technology Finance Group, Inc.
      in
      2000. Additionally, Mr. VanHellemont served as senior vice president of
      Thomson-McKinnon Securities and spent over 10 years in senior positions at
      CMI
      Corp. Mr. VanHellemont serves as Chairman of the Audit Committee and is a member
      of the Compensation Committee of the Board of Directors. The Board of Directors
      has determined that Mr. VanHellemont is independent, as that term is defined
      under the enhanced independence standards for audit committee members in the
      Securities Exchange Act of 1934 and rules there under.




*Geoffrey
      A. Smith* was
      appointed to the Board of Directors in September 2005 to fill a vacancy. His
      term of office expires at the 2008 annual meeting. Mr. Smith is the founder
      and
      president of LP Enterprises, LLC. LP Enterprises, LLC provides Information
      Technology, Strategy, and Customer Relationship Management expertise across
      a
      broad range of direct clients - private sector, corporations, non-profits and
      the sports industry. From 1979 through 2005, he worked for Procter & Gamble.
      During his career with P & G, he progressed through a variety of IT/business
      responsibilities, ultimately reaching the role of Deputy CIO. He is a graduate
      of Cornell University with a B.S. degree in Industrial Engineering and
      Operations research. Mr. Smith is on the Board of Tech Corps Ohio, a non-profit
      dedicated to the enhancement of K-12 education through the effective use of
      technology in schools. Mr. Smith is a member of the Audit Committee and a member
      of the Corporate Governance Committee. The board of Directors has determined
      that Mr. Smith is independent, as that term is defined under the enhanced
      independence standards for audit committee members in the Securities Exchange
      Act of 1934 and rules there under.




*John
      F. Cunningham* was
      appointed to the Board of Directors in September 2005 to fill a vacancy. His
      term of office expires at the 2008 annual meeting. Mr. Cunningham is the
      Chairman and CEO of Cunningham & Co, Inc., which offers highly specialized
      strategic and valuation services to technology and computer related
      companies.  From 1985 to 1989, he served as chairman and CEO of CCI, an
      Amex-listed company. Previously, Mr. Cunningham served as president and chief
      operating officer of Wang Laboratories. Mr. Cunningham is a Trustee Associate
      of
      Boston College and an independent trustee director of Federated Funds.  He
      has previously served as a director of the First National Bank of Boston, Apollo
      Computer Inc., Computervision Corp., EMC Corp., and Honeywell Federal Systems
      Corp. Mr. Cunningham serves as Chairman of the Corporate Governance Committee
      and is a member of the Compensation Committee of the Board of
      Directors.




In
      February 2005, Joel L. Owens resigned as Chief Operating Officer for personal
      reasons.




None
      of
      the Directors or Executive Officers of the Company:




·
            have
                filed a bankruptcy petition or served as a general partner or an
                executive
                officer of any entity that has filed or had filed against it a bankruptcy
                petition;




·
            have
                been convicted in a criminal proceeding or is the subject of a pending
                criminal proceeding;






34




·
            are
                subject to any order, judgment or decree, not subsequently reversed,
                suspended or vacated, of any court of competent jurisdiction, permanently
                or temporarily enjoined, barred or suspended or otherwise limited
                in their
                involvement in any type of business, securities or banking activities;
                or




·
            have
                been found by a court of competent jurisdiction in a civil action,
                the
                Commission or the Commodity Futures Trading Commission to have violated
                federal or state securities or commodities law and the judgment has
                not
                been reversed, suspended or
                vacated.




**Code
      of Ethics for Staff Members and Directors**





The
      Company has adopted a Code of Ethics for Staff Members and Directors, which
      applies to all employees, including our Chief Executive and Chief Financial
      Officers. The Code is available on the “Investor Relations” portion of our web
      site at www.qsgi.com.




**Compliance
      with Section 16(a) of the Exchange Act**




We
      are in
      compliance with Section 16(a) of the Exchange Act.




**Item
      10.**  **Executive
      Compensation**




**Oversight
      of Executive Compensation Program**




The
      Compensation Committee (the “Committee”), composed entirely of independent
      directors, administers QSGI's executive compensation program. The role of the
      Committee includes establishing and overseeing compensation and benefit programs
      for our executive officers including the Chief Executive Officer (“CEO”), the
      other executive officers and other key executives listed in the Summary
      Compensation Table (the “Named Executives”). The Committee also evaluates the
      performance of the CEO and reviews the performance of other Named Executives
      every year. The Committee reviews management performance, succession planning
      and executive development on a regular and ongoing basis with formal reviews
      conducted at least annually. Elements of our executive compensation program
      include: base salary; annual incentive bonus; long-term equity-based incentive
      awards; and employee benefits and executive perquisites.




In
      establishing and overseeing the program, the Committee’s goal is to ensure that
      we can attract and retain superior management talent critical to our long-term
      success. To ensure that executive compensation is aligned with the performance
      of QSGI and the interests of its shareholders, a significant portion of
      compensation available to executives is linked directly with financial results
      and other factors that influence shareholder value.




**Compensation
      Philosophy and Objectives**




The
      Committee’s policy is to compensate and reward the CEO and other Named
      executives based on the combination of some or all of the following factors,
      depending on the executive’s responsibilities: corporate performance, business
      unit performance and individual performance. The Committee evaluates corporate
      performance and business unit performance by reviewing the extent to which
      QSGI
      has accomplished strategic business objectives, such as revenue growth, earnings
      and cash flow. The Committee also evaluates individual performance by reviewing
      actual accomplishments. The Committee determines increases in base salary and
      annual cash incentive awards based on a combination of actual accomplishments,
      corporate performance and business unit performance and may recommend cash
      incentive awards to reward executive officers and other key executives even
      if
      corporate performance may not meet expectations. It is the Committee's belief
      that it is prudent to provide competitive base salaries and benefits in order
      to
      attract and retain the management talent necessary to achieve our strategic
      long-term objectives.






35




Based
      on
      these philosophies and objectives, the Committee believes that QSGI's executive
      compensation program should consist of the following elements:




**•**
            
            Base
                salary,**•**
            
            Annual
                cash incentive opportunity,**•**
            
            Long-term
                equity-based incentive awards, and**•**
            
            Benefits
                and executive perquisites




Additional
      details on each element of compensation program are outlined below.




**Base
      Salaries**




The
      base
      salary takes into account individual duties, responsibilities, scope of control
      and accountability for each position. The Committee also considers the
      competitiveness of the base salary. The Committee reviews salaries of the CEO
      and other Named Executives annually and awards increases, as appropriate. The
      Committee approves all increases in base salary for the CEO and other Named
      Executives in advance.




**Annual
      Incentive Compensation**




Annual
      incentive compensation bonus awards are available to the CEO and other Named
      Executives based on achievement of our short-term business objectives,
      stockholders’ interests as a whole, individual performance which includes long
      hours, hard work and dedication to the Company's future and its goals. The
      Committee reviews the individual performance, attainment of our short-term
      business objectives and stockholders' interests as a whole and recommends a
      bonus based on a combination of these factors and may recommend cash incentive
      awards to reward the CEO and other Named Executives even if corporate
      performance may not meet expectations. It is the Committee's belief that it
      is
      prudent to provide competitive base salaries and benefits in order to attract
      and retain the management talent necessary to achieve our strategic long-term
      objectives.




**Long-Term
      Equity-Based Incentive Compensation**




The
      Committee provides stock incentives to the CEO and other Named Executives that
      are tied to QSGI's long-term performance in order to link the executive’s
      interests to those of our shareholders and to encourage stock ownership by
      executives.




36


The
      2002
      Flexible Stock Plan, which was approved by our shareholders in January 2002,
      provides for the granting of stock options, performance-based share awards
      and
      restricted shares to the CEO and other Named Executives, and other employees.
      The Committee believes that the stock options, performance-based share awards
      and restricted shares granted under the Stock Plan provide a significant link
      between the compensation of the CEO and other Named Executives on the one hand
      and QSGI's long-term goals and shareholders’ interests on the other.




Since
      2002, annual grants of equity-based incentive awards to our CEO and other Named
      Executives have consisted of stock options. Such awards are usually made by
      the
      Committee at its February meeting. Generally, the CEO and other Named
      Executives, receive annual grants with an exercise price of the options based
      on
      the closing price of the Company's stock on the date the grant. Details on
      these
      equity awards are outlined below. Stock options are granted at other times
      during the year only in conjunction with the hiring or promotion of employees
      and then only as approved by the Committee and pursuant to the terms of the
      Stock Plan.




Stock
      options granted under the Flexible Stock Plan may vest ratably, or over a period
      of five or ten years. The term is at the discretion of the Committee. The number
      of shares of stock underlying options granted to the CEO and each Named
      Executives in 2006 is shown in the table below. The number of shares, option
      exercise prices, and expiration dates relating to all outstanding stock options
      that are held by the CEO and each of the Named Executives as of
      December 31, 2006, are shown in the table below. Information relating to
      options exercised during 2006 for the CEO and each Named Executive is shown
      in
      the table below.




**Benefits
      and Executive Perquisites**




The
      Committee believes that attracting and retaining superior management talent
      requires an executive compensation program that is competitive in all respects
      with the programs provided in the market place. In addition to salaries,
      incentive bonus and stock awards, competitive executive compensation programs
      include retirement and welfare benefits and reasonable executive perquisites.
      At
      QSGI, executive officers participate in the same retirement and welfare benefit
      plans as all salaried employees. We also provide certain perquisites to
      executive officers, subject to an annual allowance approved by the Committee.
      The Committee reviews actual spending on executive perquisites annually.




**Retirement
      Benefits**




The
      Company contributes 3% of an eligible employee's annual compensation to a
      qualified 401(k) savings plan. A participant in the plan may elect to contribute
      additional funds subject to annual limits established under the Internal Revenue
      Code. Employee and Company matching contributions are fully vested immediately.
      Participants may receive distribution of their QSGI Savings Plan accounts any
      time after they cease service with the Company.




**Welfare
      Benefits**


All
      executive officers, including the Named Executives, are eligible for welfare
      benefits from QSGI including: medical, dental, life insurance, short-term
      disability, and long-term disability. Executives participate in these plans
      on
      the same basis and subject to the same costs, terms and conditions as other
      salaried employees of the same defined employee class.




**Perquisites**




QSGI
      provides a taxable allowance for club membership dues of up to $20,000 as a
      perquisite for the CEO.






37




**Tax
      Implications of Executive Compensation**




Section 162(m)
      of the Internal Revenue Code imposes a limit, with certain exceptions, on the
      amount that a publicly held corporation may deduct in any year for the
      compensation paid to its five most highly compensated officers. The Committee
      believes that the annual incentive bonuses paid and the awards and options
      granted pursuant to the Stock Plan will qualify as “performance-based”
compensation and will meet the requirements of the current tax law and Internal
      Revenue Service regulations so as to preserve the tax deductibility of the
      executive compensation paid pursuant to such plans. The Committee attempts
      to
      structure executive compensation to preserve tax deductibility and consistent
      with the overall compensation objectives and philosophy discussed
      above.




The
      following summary compensation table sets forth all compensation awarded to,
      earned by, or paid to the named executive officers and its three other most
      highly compensated executive officers that was paid by us during the fiscal
      years ended December 31, 2006 and 2005.


Summary
                  Compensation TableName
                  and Principal
                Position
              Year
              Salary
                ($)
              Bonus
                  ($)
              Stock
                  Awards ($)
              Option
                Awards
                  ($)
              Non-Equity
                  Incentive
                Plan
                  Compensation Earnings ($)
              Change
                  in Pension Value and Nonqualified Deferred Compensation Earnings
                  ($)
              
              All
                  Other Compensation ($)
              
              Total
                  ($)Marc
                  Sherman(1)(2)
              2006
              $
                  424,000
              $
                  67,690
              -
              -
              -
              -
              
              $
                  20,000
              
              $
                  511,690Chairman,
                  CEO and
              2005
              $
                  424,000
              $
                  100,000
              -
              $1,845,000
              -
              -
              
              $
                  20,000
              
              $2,389,000PresidentSeth
                  A. Grossman(1)(3)
              2006
              $
                  339,200
              $
                  51,455
              -
              -
              -
              -
              
              -
              
              $
                  390,655President
                  and Chief
              2005
              $
                  267,446
              -
              -
              $6,129,000
              -
              -
              
              -
              
              $6,396,446Operating
                  OfficerEdward
                  L. Cummings(1)(2)
              2006
              $
                  254,400
              $
                  24,270
              -
              -
              -
              -
              
              -
              
              $
                  278,670CFO
                  and Treasurer
              2005
              $
                  254,400
              $
                  100,000
              -
              $922,000
              -
              -
              
              -
              
              $1,276,400Joel
                  L. Owens(1)
              2006
              $
                  463,877
              -
              -
              -
              -
              -
              
              -
              
              $
                  463,877Vice
                  President
              2005
              $
                  468,216
              -
              -
              -
              -
              -
              
              -
              
              $
                  468,216Vivek
                  J. Agarwal(4)
              2006
              $
                  200,000
              -
              -
              -
              -
              -
              
              -
              
              $
                  200,000Vice
                  President
              2005
              $
                  151,538
              -
              -
              $578,000
              -
              -
              
              -
              
              $
                  729,538


(1)
            See
                “Employment Contracts” below for agreements entered into with executive
                officers.


(2)
            Based
                on the grant date fair value of $1.85 per option share which was
                derived
                using the Black-Scholes option pricing model and is not intended
                to
                forecast future appreciation of the Company’s common share price. The
                Black-Scholes model was used with the following assumptions: dividend
                yield of 0%; expected volatility of 94.2%; risk-free interest rate
                of
                4.30%; and expected lives of 5 years.  (3)
            Based
                on the grant date fair value of $2.04 per option share which was
                derived
                using the Black-Scholes option pricing model and is not intended
                to
                forecast future appreciation of the Company’s common share price. The
                Black-Scholes model was used with the following assumptions: dividend
                yield of 0%; expected volatility of 95.5%; risk-free interest rate
                of4.18%; and expected lives of 5 years.  (4)
            Based
                on the grant date fair value of $2.03 per option share which was
                derived
                using the Black-Scholes option pricing model and is not intended
                to
                forecast future appreciation of the Company’s common share price. The
                Black-Scholes model was used with the following assumptions: dividend
                yield of 0%; expected volatility of 94.2%; risk-free interest rate
                of
                4.30%; and expected lives of 5 years.


38




***Grants
      of Plan-Based Awards***




The
      following table contains information concerning the grant of Stock Options
      to
      the named executive officers during 2006:


Grants
                      of Plan-Based AwardsName
                  Grant
                      Date
                  Estimated
                      Future Payouts Under Non-Equity Incentive Plan Awards
                  
                  Estimated
                      Future Payouts Under Equity Incentive Plan Awards
                  
                  All
                      Other Stock Awards: Number of Shares of Stock or Units (#)
                  
                  All
                      Other Option Awards: Number of Securities Underlying Options
                      (#)
                  Exercise
                      or Base Price of Option Awards ($/Sh)Threshold
                      ($)
                  Target
                      ($)
                  Maximum
                      (#)
                  
                  Threshold
                    ($)
                  Target
                      ($)
                  Maximum
                      (#)Marc
                      Sherman
                  -
                  -
                  -
                  -
                  
                  -
                  -
                  -
                  
                  -
                  
                  -
                  -Seth
                      A. Grossman
                  -
                  -
                  -
                  -
                  
                  -
                  -
                  -
                  
                  -
                  
                  -
                  -Edward
                      L. Cummings
                  -
                  -
                  -
                  -
                  
                  -
                  -
                  -
                  
                  -
                  
                  -
                  -Joel
                      L. Owens
                  -
                  -
                  -
                  -
                  
                  -
                  -
                  -
                  
                  -
                  
                  -
                  -Vivek
                      J. Agarwal
                  -
                  -
                  -
                  -
                  
                  -
                  -
                  -
                  
                  -
                  
                  -
                  -




***Outstanding
      Equity Awards at Fiscal Year-End***




The
      following table sets forth information with respect to the named executive
      officers concerning Equity Awards held on December 31, 2006:


**Outstanding
                  Equity Awards at Fiscal Year-End**Option
                  Awards
              
              Stock
                  AwardsName
              
              Number
                  of Securities Underlying unexercised Options (#) Exercisable
                  (1)
              Number
                  of Securities Underlying unexercised Options (#)
                  Unexercisable
              Equity
                  Incentive Plan Awards: Number of Securities Underlying Unexercised
                  Unearned Options (#)
              
              Option
                  Exercise Price ($)
              
              Option
                  Expiration Date
              
              Exercisable
              
              UnexercisableMarc
                  Sherman
              
              250,000
              --
              --
              
              $0.026
              
              2011
              
              --
              
              --Marc
                  Sherman
              
              125,000
              --
              --
              
              $0.026
              
              2012
              
              --
              
              --Marc
                  Sherman
              
              1,000,000
              --
              --
              
              $2.00
              
              2014
              
              --
              
              --Marc
                  Sherman
              
              500,000
              --
              --
              
              $1.44
              
              2014
              
              --
              
              --Marc
                  Sherman
              
              500,000
              --
              --
              
              $1.90
              
              2014
              
              --
              
              --Marc
                  Sherman
              
              1,000,000
              --
              --
              
              $2.50
              
              2015
              
              --
              
              --Seth
                  A. Grossman
              
              125,000
              --
              --
              
              $2.13
              
              2013
              
              --
              
              --Seth
                  A. Grossman
              
              100,000
              --
              --
              
              $2.00
              
              2014
              
              --
              
              --Seth
                  A. Grossman
              
              100,000
              --
              --
              
              $1.44
              
              2014
              
              --
              
              --Seth
                  A. Grossman
              
              100,000
              --
              --
              
              $1.90
              
              2014
              
              --
              
              --Seth
                  A. Grossman
              
              3,000,000
              --
              --
              
              $2.75
              
              2015
              
              --
              
              --Edward
                  L. Cummings
              
              250,000
              --
              --
              
              $0.026
              
              2011
              
              --
              
              --Edward
                  L. Cummings
              
              100,000
              --
              --
              
              $0.026
              
              2012
              
              --
              
              --Edward
                  L. Cummings
              
              250,000
              --
              --
              
              $2.00
              
              2014
              
              --
              
              --Edward
                  L. Cummings
              
              250,000
              --
              --
              
              $1.44
              
              2014
              
              --
              
              --Edward
                  L. Cummings
              
              250,000
              --
              --
              
              $1.90
              
              2014
              
              --
              
              --Edward
                  L. Cummings
              
              500,000
              --
              --
              
              $2.50
              
              2015
              
              --
              
              --Joel
                  L. Owens
              
              60,000
              --
              --
              
              $1.66
              
              2014
              
              --
              
              --Vivek
                  J. Agarwal
              
              100,000
              --
              --
              
              $2.75
              
              2009
              
              --
              
              --Vivek
                  J. Agarwal
              
              100,000
              --
              --
              
              $2.75
              
              2010
              
              --
              
              --Vivek
                  J. Agarwal
              
              100,000
              --
              --
              
              $2.75
              
              2011
              
              --
              
              --




(1)
            All
                options have vested.




39




***Options
      Exercises and Stock Vested***


**Outstanding
                  Equity Awards at Fiscal Year-End**Option
                  Awards
              
              Stock
                  AwardsName
              
              Number
                  of Shares Acquired on Exercise (#)
              Value
                  Realized on Exercise ($)
              
              Exercisable
              
              UnexercisableMarc
                  Sherman
              
              --
              --
              
              --
              
              --Seth
                  A. Grossman
              
              --
              --
              
              --
              
              --Edward
                  L. Cummings
              
              --
              --
              
              --
              
              --Joel
                  L. Owens
              
              --
              --
              
              --
              
              --Vivek
                  J. Agarwal
              
              --
              --
              
              --
              
              --




***Pension
      Benefits***




None.
      Not
      applicable.




***Nonqualified
      Deferred Compensation***




None.
      Not
      applicable.




***Compensation
      Pursuant to Plans***




Other
      than as disclosed above, the Company has no plans pursuant to which cash or
      non-cash compensation was paid or distributed during the last fiscal year,
      or is
      proposed to be paid or distributed in the future, to the individuals described
      above.




***Compensation
      of Directors***




Beginning
      in the first quarter of 2005, the non-employee director compensation was changed
      from receiving no compensation to fixed quarterly fees in the amount of $6,250
      per non-employee director. Such fee may be paid in cash, options or in shares
      of
      the Company’s Common Stock, at the election of the board of directors.
      Reasonable travel expenses are reimbursed when incurred. Individuals who become
      directors of the Company are automatically granted, on the date they become
      directors, an initial non-qualified stock option to purchase 100,000 shares
      of
      Common Stock, $.01 par value, at the closing price of the Company's Common
      Stock, expiring five years from the grant date. Directors who are not also
      executive officers are not eligible to participate in any other benefit plan
      of
      the Company.






40




Director
                  CompensationName
                  of Director
              Fees
                  Earnedor
                Paid
                  in Cash ($)
              Stock
                  Awards ($)
              Option
                  Awards ($)
              Non-Equity
                  Incentive Plan Compensation ($)
              Change
                  in Pension Value and Nonqualified Deferred Compensation Earnings
                  ($)
              
              All
                  Other Compensation ($)
              
              Total
                  ($)John
                  Cunningham
              $
                  25,000
              -
              -
              -
              -
              
              -
              
              $
                  25,000R.
                  Keith Elliott
              $
                  25,000
              -
              -
              -
              -
              
              -
              
              $
                  25,000Geoffrey
                  Smith
              $
                  25,000
              -
              -
              -
              -
              
              -
              
              $
                  25,000Robert
                  W. VanHellemont
              $
                  25,000
              -
              -
              -
              -
              
              -
              
              $
                  25,000




***Compensation
      Committee Interlocks and Insider Participation***




None.




***Employment
      Contracts and Termination of Employment, and Change-in-Control
      Arrangements***




The
      Company entered into employment and non-compete agreements with the following
      named executive officers.




**Name**
            **Length**
            **Commencing**
            **Base
                Compensation**Marc
                Sherman
            3
                Year
            (1)
            October
                1, 2004
            $
                424,000Seth
                A. Grossman
            3
                Year
            (2)
            March
                14, 2005
            $
                339,200Edward
                L. Cummings
            3
                Year
            (1)
            October
                1, 2004
            $
                254,400Joel
                L. Owens
            2
                Year
            (3)
            February
                14, 2005
            $
                300,000
            (4)




(1)
            The
                term is for continuously rolling three year periods unless either
                party
                gives the other party notice that it wishes to cease the continuously
                rolling term provision feature with the next contract period (i.e.
                October
                1 of each year) and thereby fixing the term of the period of three
                years
                from the next contract anniversary. The employment agreements include
                certain early termination provisions in the event of the employee’s death,
                retirement, or upon the occurrence of certain events of defaults
                in
                performance by either the Company or the employee, as applicable.




(2)
            The
                term is for continuously rolling three year periods unless either
                party
                gives the other party notice that it wishes to cease the continuously
                rolling term provision feature with the next contract period (i.e.
                January
                1 of each year) and thereby fixing the term of the period of three
                years
                from the next contract anniversary. The employment agreements include
                certain early termination provisions in the event of the employee’s death,
                retirement, or upon the occurrence of certain events of defaults
                in
                performance by either the Company or the employee, as applicable.




(3)
            The
                term is for two years ending February 14, 2007, and shall automatically
                renew for 1/2 year terms unless either party gives the other party
                written
                notice at least six (6) months prior to the commencement of the next
                employment period. The employment agreement includes certain early
                termination provisions in the event of the employee’s death, retirement,
                or upon the occurrence of certain events.




(4)
            The
                employment agreement provides for a bonus of 20% of net income after
                payment of all taxes (calculated at a tax rate of 38%) of the Data
                Center
                Maintenance segment of the Company. The employment agreement provides
                for
                an increase in the base salary to $350,000 commencing February 14,
                2008.






***Key
      provisions of Employment and Non-Compete Agreements for those executives with
      a
      three year contract***




*Compensation.* In
      addition to the base compensation of each named executive listed above, each
      named executive is entitled to receive such bonuses, incentive compensation,
      and
      other compensation, if any, as the Company’s board of directors or the
      compensation committee thereof, or other designated committee shall award such
      executive from time to time whether in cash, Company stock, stock options,
      other
      stock based compensation, other form of remuneration, or any combination of
      the
      foregoing.




41




*Change
      of Control or Early Termination.* In the
      event of a change in control of the Company or early termination, all options
      granted to the executives will immediately vest, to the extent not already
      vested, and will become exercisable in accordance with the plan or terms and
      conditions under which they were granted. In the event of early termination,
      the
      Company shall pay the employee a severance payment equal to three (3) times
      the
      amount of compensation paid in the twelve (12) months prior to termination.
      This
      amount is to be paid over thirty six (36) months in equal payments. If, after
      the announcement of a change in control or a change of control, the employee
      may
      terminate his employment at his sole discretion within one year after the change
      of control. In the event of such termination, the Company shall pay employee
      a
      severance payment equal to three (3) times the then bonus plus three (3) times
      the base salary minus $1.00.




*Excise
      Gross Up.* In the
      event that any payment or benefit payable to an executive under his employment
      contract, and/or under any other agreement or arrangement with the Company
      or
      any person whose actions result in a change of control of the Company, is
      covered by Section 280G(b)(2) of the Internal Revenue Code of 1986 and is
      subject to the excise tax under Section 4999 of the Internal Revenue Code of
      1986, as amended, the Company shall reduce the payment by the smallest amount
      required to eliminate the imposition of the Section 4999 tax.




*Vesting
      of Options.* In the
      event of termination of the executive’s employment for any reason other than
      termination by the Company due to his material default, as described in the
      employment contract, all stock options granted to him by the Company (or any
      subsidiary or affiliate) whether granted under and pursuant to a plan or
      otherwise, will become immediately exercisable to the extent not already
      exercisable and will remain exercisable until their expiration
      date.




*Non-Compete
      Provisions.* During
      the employment term and for a period of three years after termination of
      employment, if such termination is for any reason other than death, the
      executive shall not engage, directly or indirectly, either on his own behalf
      or
      on behalf of any other person, firm, corporation or other entity, in any
      business competitive with the business of the Company, or own more than 5%
      of
      any such firm, corporation or other entity. In addition, the executive must
      furnish the Company with such information, as the Company shall from time to
      time request in order to determine that executive is in compliance with his
      non-compete agreement.




The
      following table shows post employment compensation as if the triggering event
      took place on December 31, 2006:


**Post
                  Employment Compensation**Name
              
              2007
                  ($)
              2008
                  ($)
              2009
                  ($)Marc
                  Sherman
              
              491,690
              491,690
              491,690Seth
                  A. Grossman
              
              390,655
              390,655
              390,655Edward
                  L. Cummings
              
              278,670
              278,670
              278,670




***Key
      provisions of Employment and Non-Compete Agreements for the executive with
      a two
      year contract***




*Compensation.* In
      addition to the base compensation of each named executive listed above, each
      named executive is entitled to receive such bonuses, incentive compensation,
      and
      other compensation, if any, as the Company’s board of directors or the
      compensation committee thereof, or other designated committee shall award such
      executive from time to time whether in cash, Company stock, stock options,
      other
      stock based compensation, other form of remuneration, or any combination of
      the
      foregoing.




42




*Vesting
      of Options.* In the
      event of termination of the executive’s employment for any reason other than
      termination by the Company due to his material default, as described in the
      employment contract, all stock options granted to him by the Company (or any
      subsidiary or affiliate) whether granted under and pursuant to a plan or
      otherwise, will become immediately exercisable to the extent not already
      exercisable and will remain exercisable until their expiration
      date.




*Non-Compete
      Provisions.* During
      the employment term and for a period of up to twelve months after termination
      of
      employment, if employment is terminated by the Company without cause or
      executive shall resign, the executive shall not engage, directly or indirectly,
      either on his own behalf or on behalf of any other person, firm, corporation
      or
      other entity, in any business competitive with the hardware or maintenance
      segment of the Company. If employment is terminated by the Company for cause,
      the non-compete shall be for a period of six months from the date of
      termination.




**Item
      11.**  **Security
      Ownership of Management and Certain Shareholders**




***Ownership
      of Equity Securities in the Company***




The
      following table sets forth information regarding beneficial ownership of the
      Company’s Common Stock by each director and by each executive officer named in
      the Summary Compensation Table and by all the directors and executive officers
      as a group as of December 31, 2006:




**Title
                  of Class**
              **Name
                  and Address of Beneficial Owner**
              **Amount
                  and Nature of**
                **Beneficial
                  Owner****(1)**
              **Percent
                  of Class**Common
              Marc
                  Sherman(2)
                c/o
                  70 Lake Drive
                Hightstown,
                  NJ 08520
              6,016,300
              13.9%Common
              Seth
                  A. Grossman
                c/o
                  70 Lake Drive
                Hightstown,
                  NJ 08520
              3,425,000
              7.9%Common
              Edward
                  L. Cummings
                c/o
                  70 Lake Drive
                Hightstown,
                  NJ 08520****
              3,716,200
              8.6%Common
              Joel
                  L. Owens
                c/o
                  70 Lake Drive
                Hightstown,
                  NJ 08520****
              70,000
              *Common
              Vivek
                  J. Agarwal
                c/o
                  70 Lake Drive
                Hightstown,
                  NJ 08520
              300,000
              *Common
              David
                  A. Harris
                c/o
                  70 Lake Drive
                Hightstown,
                  NJ 08520
              425,000
              1.0%Common
              R.
                  Keith Elliott
                c/o
                  70 Lake Drive
                Hightstown,
                  NJ 08520
              525,000
              1.2%Common
              John
                  F. Cunningham
                c/o
                  70 Lake Drive
                Hightstown,
                  NJ 08520****
              255,000
              *
   43
  Common
              Geoffrey
                  A. Smith
                c/o
                  70 Lake Drive
                Hightstown,
                  NJ
              100,000
              *Common
              Robert
                  W. VanHellemont
                c/o
                  70 Lake Drive
                Hightstown,
                  NJ 08520
              298,500
              *Common
              All
                  Directors and Executive Officers as a Group (10 Persons)
              15,131,000
              34.9%




*
      The
      amount shown is less than 1% of the outstanding shares of common
      stock.


1.
            This
                table includes presently exercisable stock options. The following
                directors and executive officers hold the number of presently exercisable
                options (all of which may be exercised at any time) set forth following
                their respective names: Edward L. Cummings - 1,600,000; R. Keith
                Elliott -
                525,000; Seth A. Grossman -3,425,000; Vivek J. Agarwal - 300,000;
                David A.
                Harris - 275,000; Joel A. Owens - 60,000; Marc Sherman -3,375,000;
                John F.
                Cunningham - 100,000; Geoffrey A. Smith - 100,000; Robert W. VanHellemont
                - 275,000; and all directors and executive officers as a group (10
                persons) - 10,035,000.


2.
            Includes
                85,300 shares beneficially owned by Mr. Sherman’s children for whom Mr.
                Sherman has sole voting and dispositive
                power.





Set
      forth
      in the table below is information, as of March 12, 2007, with respect to persons
      known to the Company (other than the directors and executive officers shown
      in
      the preceding table) to be the beneficial owners of more than five percent
      of
      the Company’s issued and outstanding Common Stock:




**Name
                and Address**
            
            **Number
                of Shares Beneficially Owned**
            
            **Percent
                Of Class**Circle
                T Partners, LP
              623
                Fifth Avenue
              Suite
                2501
              New
                York, NY 10022
            
            2,923,278
            
            6.7%Pike
                Capital Partners, LP
              275
                Madison Avenue
              Suite
                418
              New
                York, NY 10016
            
            5,555,972
            
            12.8%




***Securities
      authorized for issuance under equity compensation
      plans***




This
      information is presented in Part II, Item 5 - *“Market
      for Common Equity and Related Stockholder Matters”* above.




**Item
      12**  **Certain
      Relationships and Related Transactions**




***Loans
      from Principal Stockholders/Executive Officers***




As
      of
      December 31, 2006 and 2005, there were no outstanding loans or notes due to
      or
      due from principal stockholders or executive officers.




***Sales
      to Related Party***




The
      Company had sales to Keystone Memory Group, a customer related to Marc Sherman,
      Chairman and CEO, who is a principal stockholder of the Company and Michael
      Sheerr, a former employee and officer of the Company. Keystone Memory Group
      is
      owned by Michael P. Sheerr and his wife. Mrs. Sheerr is Marc Sherman’s sister.
      Mr. Sherman has no business experience with Keystone, and Mr. Sheerr had no
      business experience with Keystone while employed by the Company.




Sales
      to
      Keystone amounted to approximately $158,000 and $857,000 for the years ended
      December 31, 2006 and 2005, respectively. No accounts receivable from this
      customer was outstanding at December 31, 2006 and 2005, respectively.






44






Keystone
      primarily sells memory upgrades for Sun, HP, Cisco, Compaq and IBM workstations,
      servers and personal computers as well as other computer parts. We sell personal
      computer memory modules to Keystone in bona fide arms-length negotiated
      transactions at competitive fair market prices. The products primarily consist
      of 32Mb, 64Mb, 128Mb and 256Mb RAM, or “Random Access Memory,”
modules.




***Other
      Related Party Transaction***




In
      2005,
      the Company signed a 24 month lease for a tractor trailer from Varilease
      Technology Finance Group, Inc., a company that is owned by one of the members
      of
      the Board of Directors. The lease is considered an operating lease. For the
      years ended December 31, 2006 and 2005, rent expense for this lease amounted
      to
      $179,585 and, respectively. No accounts payable were due to this vendor at
      December 31, 2006. Accounts payable due to this vendor amounted to $41,218
      at
      December 31, 2005.




***Shares
      issued to Principal Stockholders/Executive Officers***




Principal
                Stockholder /
              Executive
                Officer
            **Date
                Issued**
            **Note**
            **Issued
                For**
            **Number
                of**
              **Common**
              **Shares**Edward
                L. Cummings
            Oct
                - 2001
            A
            Capital
                Contribution
            5,000,000Jan
                - 2002
            B
            Merger
                Consideration
            1,800,000Dec
                - 2002
            C
            Compensation
            500,000David
                A. Loppert
            Oct
                - 2001
            A
            Capital
                Contribution
            5,000,000Jan
                - 2002
            B
            Merger
                Consideration
            1,800,000Dec
                - 2002
            C
            Compensation
            500,000Carl
                C. Saracino
            Oct
                - 2001
            A
            Capital
                Contribution
            5,000,000Jan
                - 2002
            B
            Merger
                Consideration
            1,800,000Dec
                - 2002
            C
            Compensation
            500,000Michael
                P. Sheerr
            Oct
                - 2001
            A
            Capital

                Contribution
            5,000,000Jan
                - 2002
            B
            Merger
                Consideration
            1,800,000Dec
                - 2002
            C
            Compensation
            500,000Marc
                Sherman
            Oct
                - 2001
            A
            Capital
                Contribution
            5,000,000Jan
                - 2002
            B
            Merger
                Consideration
            1,800,000Dec
                - 2002
            C
            Compensation
            500,000




A.  In
      October 2001, WindsorTech, Inc. (New Jersey Company) sold an aggregate of 50,000
      shares of its common to Edward Cummings, David Loppert, Carl C. Saracino,
      Michael Sheerr and Marc Sherman in consideration for $50,000 from each of them.
      In January 2002, WindsorTech, Inc. (New Jersey Corporation) affected a 100:1
      stock split. These shares were restricted within the meaning of the Securities
      Act of 1933.




B.  On
      January 30, 2002, in connection with the Merger, Delta issued an aggregate
      of
      9,000,000 shares of its common stock to Edward Cummings, David Loppert, Carl
      C.
      Saracino, Michael Sheerr and Marc Sherman in exchange for their 25,000,000
      shares of common stock in WindsorTech, Inc. (New Jersey Corporation). The
      9,000,000 shares of common stock were valued at $250,000, or $.0278 per share.
      These shares are restricted within the meaning of the Securities Act of
      1933.






45




C.  In
      December 2002, the Compensation Committee of the Board of Directors awarded
      each
      executive officer a $13,000 bonus, payable in shares of the Company’s restricted
      common stock. Each executive officer received 500,000 restricted shares of
      common stock valued at $0.026 per share.




**It** **em
      13.**  **Exhibits
      and Financial Statements**




ExhibitsSee
                List of Exhibits filed as part of this Report on
                Form 10-KSB.The
                financial statements listed below appear immediately after page
                42.Report
                of Independent Registered Public Accounting
                Firm
            F-1Financial
                StatementsBalance
                Sheet
            F-2Statement
                Of Operations
            F-3Statement
                Of Stockholders’ Equity
            F-4Statement
                Of Cash Flows
            F-5Notes
                To Financial Statements
            F-6
                - F-32




**Item
      14.**  **Principal
      accountant fees and services**




During
      2006 and 2005, we paid the following fees, including out of pocket expense
      reimbursements, to RubinBrown LLP:




**2006**
              
              **2005**Audit
                  Fees
              
              $
              147,109
              
              $
              124,056Audit-Related
                  Fees (1)
              
              
              43,123
              
              
              11,700Tax
                  Fees (2)
              
              
              22,950
              
              
              22,870Total
              
              $
              213,182
              
              $
              158,626




(1)
      Audited-related fees include consultation concerning financial accounting and
      reporting standards and acquisitions, acquisition due diligence services, and
      work performed in connection with registration statements filed with the
      SEC.






46




(2)
      Tax
      Fees include tax planning and compliance for federal and state income
      taxes.




QSGI
      INC.’s Audit Committee approves the engagement of an accountant to render all
      audit and non-audit services prior to the engagement of the accountant based
      upon a proposal by the accountant of estimated fees and scope of the engagement.
      QSGI INC’s Audit Committee has received the written disclosure and the letter
      from RubinBrown LLP required by Independence Standards Board Standard No. 1,
      as
      currently in effect, and has discussed with RubinBrown LLP their independence.




**SIGNATURES**




In
      accordance with Section 13 or 15(d) of the Exchange Act, the Registrant caused
      this report to be signed on its behalf by the undersigned, thereunto duly
      authorized.




**QSGI
                INC.**
              (Registrant)Dated:March
                26, 2007
            By:
            /s/Marc ShermanMarc
                ShermanChief
                Executive Officer





In
      accordance with the Exchange Act, this report has been signed below by the
      following persons on behalf of the Registrant and in the capacities and on
      the
      dates indicated.




**Signature**
            **Title**
            **Date**/s/Marc
                Sherman
              Marc
                Sherman
            Chairman
                of the Board, and Chief
              Executive
                Officer
            March
                26, 2007/s/Seth
                A. Grossman
              Seth
                A. Grossman
            President,
                Chief Operating Officer
              and
                Director
            March
                26, 2007/s/Edward
                L. Cummings
              Edward
                L. Cummings
            Chief
                Financial Officer, Treasurer
              and
                Director
            March
                26, 2007/s/
                R. Keith Elliott
              R.
                Keith Elliott
            Director
            March
                26, 2007/s/
                Robert W. VanHellemont
              Robert
                W. VanHellemont
            Director
            March
                26, 2007/s/
                Geoffrey A. Smith
              Geoffrey
                A. Smith
            Director
            March
                26, 2007/s/
                John F. Cunningham
              John
                F. Cunningham
            Director
            March
                26, 2007





49
 47




**List
      Of Exhibits**




Exhibit
                Number
            Description2.1
            Agreement
                and Plan of Merger by and between WindsorTech, Inc., Delta States
                Oil,
                Inc. and Alfred D. Morgan, Ph. D dated January 29, 2002 (incorporated
                herein by reference to Exhibit 99.1 to the Registrant’s Current Report on
                Form 8-K filed with the Commission on February 13, 2002 (Commission
                file
                number 000-07539)).2.2
            Agreement
                and plan of Merger by and among WindsorTech, Inc., Qualtech International
                Corporation and Qualtech Service Group, Inc. dated May 1,
                2004.2.3***
            Addendum
                to Agreement and Plan of Merger2.4***
            Second
                Addendum to Agreement and Plan of Merger.3.1
            Certificate
                of Amendment of Certificate of Incorporation of WindsorTech, Inc.
                **3.2
            Amended
                and Restated ByLaws of WindsorTech, Inc. (Incorporated herein reference
                to
                Exhibit 3.2 to the Registrant’s Quarterly Report on Form 10-QSB filed with
                the Commission on August 19, 2002 (Commission file number
                000-07539)).3.3
            Action
                by Consent in Writing of a Majority of Stockholders dated May 19,
                2004
                concerning Amended and Restated By Laws.3.4
            Action
                by Consent in Writing of a Majority of Stockholders dated September
                17,
                2004 increasing the number of shares of the Corporation4.1
            Specimen
                Common Stock Certificate of WindsorTech, Inc. (Incorporated herein
                reference to Exhibit 4.1 to the Registrant’s Quarterly Report on Form
                10-QSB filed with the Commission on August 19, 2002 (Commission file
                number 000-07539)).4.2
            Form
                of Stock Purchase Agreements with Barron Partners, L.P., Guerrilla
                Capital, and Odin Partners et al. dated May 26, 2004.4.3
            Form
                of Registration Rights Agreements with Barron Partners, L.P., Guerrilla
                Capital, and Odin Partners et al. dated May 26, 2004.4.4
            Form
                of Common Stock Purchase Warrant at $1.50 per share dated May 28,
                2004.4.5
            Form
                of Common Stock Purchase Warrant at $3.60 per share dated May 28,
                20044.6
            Form
                of Registration Rights Agreement with Joel Owens and Jolene Owens
                dated
                May 1, 2004.10.1*
            Employment
                and Non-Compete Agreement - Edward L. Cummings **10.2*
            Employment
                and Non-Compete Agreement - David A. Loppert **10.3*
            Employment
                and Non-Compete Agreement - Carl C. Saracino **10.4*
            Employment
                and Non-Compete Agreement - Michael P. Sheerr **10.5*
            Employment
                and Non-Compete Agreement - Marc Sherman **10.6*
            2002
                Flexible Stock Plan (Incorporated herein reference to Exhibit 10.6
                to the
                Registrant’s Quarterly Report on Form 10-QSB filed with the Commission on
                April 16, 2002 (Commission file number 000-07539)).10.7
            Promissory
                Note executed by the Company. As of April 24, 2002 this note was
                paid in
                full (Incorporated herein reference to Exhibit 10.7 to the Registrant’s
                Quarterly Report on Form 10-QSB filed with the Commission on August
                19,
                2002 (Commission file number 000-07539)).






48






10.8
            Loan
                Agreement by and among Marc Sherman, Edward L. Cummings, David A.
                Loppert,
                Carl C. Saracino, Michael P. Sheerr and WindsorTech, Inc., on and
                as of
                April 24, 2002 (Incorporated herein reference to Exhibit 10.8 to
                the
                Registrant’s Quarterly Report on Form 10-QSB filed with the Commission on
                August 19, 2002 (Commission file number 000-07539)).10.9
            Lease
                Agreement (Incorporated herein reference to Exhibit 10.9 to the
                Registrant’s Quarterly Report on Form 10-QSB filed with the Commission on
                August 19, 2002 (Commission file number 000-07539)).10.10
            Amendment
                to Loan Agreement by and among Marc Sherman, Edward L. Cummings,
                David A.
                Loppert, Carl C. Saracino, Michael P. Sheerr and WindsorTech, Inc.,
                on and
                as of September 30, 2002 (Incorporated herein reference to Exhibit
                10.10
                to the Registrant’s Quarterly Report on Form 10-QSB filed with the
                Commission on November 11, 2002 (Commission file number
                000-07539)).10.11
            Second
                Amendment to Loan Agreement by and among Marc Sherman, Edward L.
                Cummings,
                David A. Loppert, Carl C. Saracino, Michael P. Sheerr and WindsorTech,
                Inc., on and as of February 28, 2003 (Incorporated herein reference
                to
                Exhibit 10.11 to the Registrant’s Quarterly Report on Form 10-QSB filed
                with the Commission on May 13, 2003 (Commission file number
                000-07539)).10.12
            Employment
                and Non-Compete Agreement - Joel L. Owens10.13**
            Third
                Amendment to Loan Agreement by and among Marc Sherman, Edward L.
                Cummings,
                Carl C. Saracino, Michael P. Sheerr and WindsorTech, Inc., on and
                as of
                March 29, 2004.12.1***
            Statement
                re computation of ratios.16.1
            Letter
                from Milton Reece, CPA (“Reece”) concurring with the statements made by
                the Registrant in the Current Report on Form 8-K reporting Reece’s
                resignation as the Registrant’s principal accountant (incorporated herein
                by reference to Exhibit 16 to the Registrant’s Current Report on Form 8-K
                filed with the Commission on February 13, 2002 (Commission file number
                000-07539)).23.1***
            Consent
                of RubinBrown LLP31.1***
            Chairman
                and Chief Executive Officer
                Certification31.2***
            President
                and Chief Operating Officer
                Certification31.3***
            Chief
                Financial Officer and Treasurer
                Certification32.1***
            Certifications
                Pursuant to 18 U.S.C. Section 1350, as
                Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
                2002.*
                Management contract or compensatory plan.**
                Incorporated herein by reference to the same numbered exhibit in
                the
                Registrant’s Transition Report on Form 10-KSB filed with the Commission on
                April 1, 2002 (Commission file number 000-07539).***
                Attached hereto.There
                are no other documents required to be filed as an Exhibit as required
                by
                Item 601(a) of Regulation S-B.







49
 49


***QSGI
        INC. AND SUBSIDIARIES***
 *CONSOLIDATED
        FINANCIAL STATEMENTS*
 *DECEMBER
        31, 2006*
 
  
 
 
 
 
 
 
 
  **Contents**
 **Page****Report
                      Of Independent Registered
                      Public****Accounting
                      Firm**
                  F-1**Financial
                      Statements**Consolidated
                      Balance Sheets
                  F-2Consolidated
                      Statements Of
                      Operations
                  F-3Consolidated
                      Statements Of Stockholders’
                      Equity
                  F-4Consolidated
                      Statements Of Cash
                      Flows
                  F-5Notes
                      To Consolidated Financial
                      Statements
                  F-6
                      -
                      F-32
 
 
 **Report
        Of Independent Registered**
 **Public** **Accounting
        Firm**
 
 Board
        of
        Directors and Stockholders
 QSGI
        INC.
 Hightstown,
        New Jersey
 
 We
        have
        audited the accompanying c onsolidated
        b alance
        sheets of QSGI INC. and subsidiaries as of December 31, 2006 and 2005, and
        the
        related c onsolidated statements
        of operations, stockholders’ equity and cash flows for the years then ended.
        These financial statements are the responsibility of the Company’s management.
        Our responsibility is to express an opinion on these financial statements
        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 consideration
        of
        internal control over financial reporting as a basis for designing audit
        procedures that are appropriate in the circumstances, but not for the purpose
        of
        expressing an opinion on the effectiveness of the Company's internal control
        over financial reporting. Accordingly, we express no such opinion. An audit
        also
        includes examining, on a test basis, evidence supporting the amounts and
        disclosures in the financial statements, 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 c onsolidated financial
        statements referred to above present fairly, in all material respects, the
        c onsolidated financial
        position of QSGI INC. and subsidiaries as of December 31, 2006 and 2005,
        and the
        results of their operations and their cash flows for the years then ended,
        in
        conformity with accounting principles generally accepted in the United States
        of
        America.
  /s/
        Rubin Brown LLP
 St.
        Louis, Missouri
 March
        19,
        2007
 
 Page
            F-1
 **QSGI
          INC. AND SUBSIDIARIES**
 **CONSOLIDATED
        BALANCE SHEETS**
 **Assets****December
                    31,****2006**
                
                2005**Current
                    Assets**Cash
                    and cash equivalents
                
                **$**
                **632,948**
                
                $
                153,794Accounts
                    receivable, net of reserve of $780,116and
                    $80,000 in 2006 and 2005, respectively
                
                
                **8,012,421**
                
                
                7,014,129Inventories
                
                
                **4,982,710**
                
                
                4,136,304Prepaid
                    expenses and other assets
                
                
                **183,069**
                
                
                227,352Deferred
                    income taxes
                
                
                **598,661**
                
                
                72,094**Total
                    Current Assets**
                
                
                **14,409,809**
                
                
                11,603,673**Property
                    And Equipment, Net**
                
                
                **410,241**
                
                
                605,887**Goodwill**
                
                
                **6,644,403**
                
                
                3,212,314**Intangibles,
                    Net**
                
                
                **2,555,584**
                
                
                2,872,240**Other
                    Assets**
                
                
                **158,784**
                
                
                116,225**$**
                **24,178,821**
                
                $
                18,410,339**Liabilities
                    And Stockholders' Equity****Current
                    Liabilities**Revolving
                    lines of credit
                
                **$**
                **3,915,825**
                
                $
                3,631,500Accounts
                    payable
                
                
                **1,382,336**
                
                
                2,254,136Accrued
                    expenses
                
                
                **601,850**
                
                
                279,090Accrued
                    payroll
                
                
                **329,658**
                
                
                264,134Deferred
                    revenue
                
                
                **517,439**
                
                
                286,595Other
                    current liabilities
                
                
                **122,784**
                
                
                29,366**Total
                    Current Liabilities**
                
                
                **6,869,892**
                
                
                6,744,821**Long-Term
                    Deferred Revenue**
                
                
                **416,239**
                
                
                117,945**Deferred
                    Income Taxes**
                
                
                **451,625**
                
                
                196,744**Total
                    Liabilities**
                
                
                **7,737,756**
                
                
                7,059,510**Redeemable
                    Convertible Preferred Stock**
                
                
                **4,220,577**
                
                
                1,967,220**Commitments
                    And Contingencies (Note 13)****Stockholders'
                    Equity**Preferred
                    shares: authorized 5,000,000 in 2006 and 2005,$0.01
                    par value, none issued
                
                
                —
                
                
                —Common
                    shares: authorized 95,000,000 in 2006 and 55,000,000in
                    2005, $0.01 par value; 31,172,716 shares issued andoutstanding
                    in 2006 and 28,670,631 issued and outstanding
                
                
                **311,727**
                
                
                286,706in
                    2005.Additional
                    paid-in capital
                
                
                **14,390,976**
                
                
                11,093,881Retained
                    earnings (deficit)
                
                
                **(2,482,215**
                **)**
                
                (1,996,978
                )**Total
                    Stockholders' Equity**
                
                
                **12,220,488**
                
                
                9,383,609**$**
                **24,178,821**
                
                $
                18,410,339
  See
        the
        accompanying notes to consolidated financial statements.
 Page
            F-2
  **QSGI
        INC. AND SUBSIDIARIES**
 CONSOLIDATED
      STATEMENTS OF OPERATIONS  **For
                    The Years****Ended
                    December 31,****2006**
                
                2005**Product
                    Revenue**
                
                **$**
                **41,111,420**
                
                $
                33,085,383**Service
                    Revenue**
                
                
                **5,297,497**
                
                
                3,300,755**Total
                    Revenue**
                
                
                **46,408,917**
                
                
                36,386,138**Cost
                    of Products Sold**
                
                
                **34,742,022**
                
                
                27,671,251**Cost
                    of Services Sold**
                
                
                **1,806,492**
                
                
                1,214,918**Cost
                    Of Sales**
                
                
                **36,548,514**
                
                
                28,886,169**Gross
                    Profit**
                
                
                **9,860,403**
                
                
                7,499,969**Selling,
                    General And Administrative Expenses**
                
                
                **9,663,812**
                
                
                8,731,946**Depreciation
                    And Amortization**
                
                
                **685,216**
                
                
                634,014**Interest
                    Expense, Net**
                
                
                **238,985**
                
                
                160,441**Loss
                    Before Benefit For Income Taxes**
                
                
                **(727,610**
                **)**
                
                (2,026,432
                )**Benefit
                    For Income Taxes**
                
                
                **(242,373**
                **)**
                
                (760,246
                )**Net
                    Loss**
                
                
                **(485,237**
                **)**
                
                (1,266,186
                )**Accretion
                    To Redemption Value Of Preferred Stock**
                
                
                **17,056**
                
                
                —**Preferred
                    Stock Dividend**
                
                
                **256,389**
                
                
                3,945**Net
                    Loss Available To Common Stockholders**
                
                **$**
                **(758,682**
                **)**
                $
                (1,270,131
                )**Net
                    Loss Per Common Share - Basic**
                
                **$**
                **(0.03**
                **)**
                $
                (0.05
                )**Net
                    Loss Per Common Share - Diluted**
                
                **$**
                **(0.03**
                **)**
                $
                (0.05
                )**Weighted
                    Average Number Of Common Shares****Outstanding
                    - Basic**
                
                
                **30,127,255**
                
                
                28,132,778**Weighted
                    Average Number Of Common Shares****Outstanding
                    - Diluted**
                
                
                **30,127,255**
                
                
                28,132,778
 
 See
          the
          accompanying notes to consolidated financial statements.
 
 Page
                F-3
 **QSGI
            INC. AND SUBSIDIARIES**
 **CONSOLIDATED
            STATEMENTS OF STOCKHOLDERS’ EQUITY**
 
 **For
            The Years Ended December 31, 2006 And 2005**
 **Additional**
                
                **Retained**
                
                **Total****Common
                    Stock**
                
                **Paid-In**
                
                **Earnings**
                
                **Stockholders'****Shares**
                
                **Amount**
                
                **Capital**
                
                **(Deficit)**
                
                **Equity****Balance
                    (Deficit) - January 1, 2005**
                
                
                25,550,007
                
                $
                255,500
                
                $
                9,421,356
                
                $
                (730,792
                )
                $
                8,946,064**Common
                    Stock Warrants****Repurchased**
                
                
                —
                
                
                —
                
                
                (1,256,210
                )
                
                —
                
                
                (1,256,210
                )**Exercise
                    Of Stock Options**
                
                
                1,801,666
                
                
                18,017
                
                
                1,241,791
                
                
                —
                
                
                1,259,808**Tax
                    Effect Of Exercise Of****Stock
                    Options**
                
                
                —
                
                
                —
                
                
                163,244
                
                
                —
                
                
                163,244**Exercise
                    Of Stock Warrants**
                
                
                1,233,333
                
                
                12,333
                
                
                1,337,667
                
                
                —
                
                
                1,350,000**Stock
                    Option Compensation**
                
                
                —
                
                
                —
                
                
                61,334
                
                
                —
                
                
                61,334**Preferred
                    Stock Dividend**
                
                
                —
                
                
                —
                
                
                (3,945
                )
                
                —
                
                
                (3,945
                )**Shares
                    Issued For Services**
                
                
                85,625
                
                
                856
                
                
                128,644
                
                
                —
                
                
                129,500**Net
                    Loss**
                
                
                —
                
                
                —
                
                
                —
                
                
                (1,266,186
                )
                
                (1,266,186
                )**Balance
                    (Deficit) - December 31, 2005**
                
                
                28,670,631
                
                
                286,706
                
                
                11,093,881
                
                
                (1,996,978
                )
                
                9,383,609**Exercise
                    Of Stock Options**
                
                
                350,000
                
                
                3,500
                
                
                5,600
                
                
                —
                
                
                9,100**Shares
                    Issued For Services**
                
                
                88,540
                
                
                885
                
                
                160,802
                
                
                —
                
                
                161,687**Common
                    Shares Issued For****Qualtech
                    Earn-out**
                
                
                2,063,545
                
                
                20,636
                
                
                3,385,954
                
                
                —
                
                
                3,406,590**Stock
                    Option Compensation**
                
                
                —
                
                
                —
                
                
                18,184
                
                
                —
                
                
                18,184**Preferred
                    Stock Dividend**
                
                
                —
                
                
                —
                
                
                (256,389
                )
                
                —
                
                
                (256,389
                )**Accretion
                    To The Redemption****Value
                    Of Preferred Stock**
                
                
                —
                
                
                —
                
                
                (17,056
                )
                
                —
                
                
                (17,056
                )**Net
                    Loss**
                
                
                —
                
                
                —
                
                
                —
                
                
                (485,237
                )
                
                (485,237
                )**Balance
                    (Deficit) - December 31, 2006**
                
                
                31,172,716
                
                $
                311,727
                
                $
                14,390,976
                
                $
                (2,482,215
                )
                $
                12,220,488
  See
          the
          accompanying notes to consolidated financial statements.  Page
                F-4
  **QSGI
            INC. AND SUBSIDIARIES**
 **CONSOLIDATED
        STATEMENTS OFCASH FLOWS**
 **For
                    The Years****Ended
                    December 31,****2006**
                
                2005**Cash
                    Flows From Operating Activities**Net
                    loss
                
                **$**
                **(485,237**
                **)**
                $
                (1,266,186
                )Adjustments
                    to reconcile net loss to net cashused
                    in operating activities:Depreciation
                    and amortization
                
                
                **685,216**
                
                
                634,014Stock
                    option compensation expense
                
                
                **18,184**
                
                
                61,334Deferred
                    income taxes
                
                
                **(271,686**
                **)**
                
                (760,465
                )Allowance
                    for doubtful accounts
                
                
                **822,965**
                
                
                88,810Common
                    stock issued for services
                
                
                **161,687**
                
                
                129,500Change
                    in assets and liabilities:Accounts
                    receivable
                
                
                **(1,821,257**
                **)**
                
                (3,371,363
                )Inventories
                
                
                **(846,406**
                **)**
                
                (1,414,799
                )Prepaid
                    expenses and other current assets
                
                
                **18,034**
                
                
                (92,280
                )Other
                    assets
                
                
                **(3,770**
                **)**
                
                (13,921
                )Accounts
                    payable, accrued expenses and other liabilities
                
                
                **139,040**
                
                
                818,711**Net
                    Cash Used In Operating Activities**
                
                
                **(1,583,230**
                **)**
                
                (5,186,645
                )**Cash
                    Flows From Investing Activities**Acquisition
                    of business, net of cash acquired
                
                
                **—**
                
                
                (86,520
                )Purchases
                    of property and equipment
                
                
                **(153,728**
                **)**
                
                (352,477
                )Proceeds
                    from sale of equipment
                
                
                **8,274**
                
                
                **—****Net
                    Cash Used In Investing Activities**
                
                
                **(145,454**
                **)**
                
                (438,997
                )**Cash
                    Flows From Financing Activities**Proceeds
                    from the issuance of redeemable preferred stock
                
                
                **2,236,301**
                
                
                1,967,220Payments
                    for financing costs
                
                
                **(40,000**
                **)**
                
                **—**Stock
                    warrants exercised
                
                
                **—**
                
                
                1,350,000Stock
                    options exercised
                
                
                **9,100**
                
                
                1,259,808Stock
                    warrants repurchased
                
                
                **—**
                
                
                (1,256,210
                )Preferred
                    stock dividends
                
                
                **(256,389**
                **)**
                
                (3,945
                )Net
                    amounts borrowed under revolving lines of credit
                
                
                **284,325**
                
                
                2,476,000Stock
                    issuance costs
                
                
                **(25,499**
                **)**
                
                —Principal
                    payments - notes payable
                
                
                **—**
                
                
                (858,376
                )**Net
                    Cash Provided By Financing Activities**
                
                
                **2,207,838**
                
                
                4,934,497**Net
                    Increase (Decrease) In Cash And Cash Equivalents**
                
                
                **479,154**
                
                
                (691,145
                )**Cash
                    And Cash Equivalents - Beginning Of Year**
                
                
                **153,794**
                
                
                844,939**Cash
                    And Cash Equivalents - End Of Year**
                
                **$**
                **632,948**
                
                $
                153,794**Supplemental
                    Disclosure Of Cash Flow Information**Income
                    taxes paid (refunds received)
                
                **$**
                **25,428**
                
                $
                (27,516
                )Interest
                    paid
                
                
                **243,196**
                
                
                135,456Supplemental
                    Cash Flow Information (Note 15)
  See
          the
          accompanying notes to consolidated financial statements.
 Page
              F-5
 **QSGI
          INC. AND SUBSIDIARIES**
 **NOTESTO
        CONSOLIDATED FINANCIAL STATEMENTS**
 **December
        31, 2006 And 2005**
  
 **1.**
              **Summary
                  Of Significant Accounting
                  Policies**
 
 **Business
        Organization**
  The
        Company is a data security and regulatory compliance provider offering a
        full
        suite of end-of-life and other life-cycle services for a Fortune 1000
        corporation’s and government client’s entire information technology (IT)
        platform. The Company offers a variety of solutions to companies whose business
        computing technologies (desktops, laptops, printers, and servers) have come
        to
        the end of their life cycle. These services include data erasure to Department
        of Defense standards for hard drives, asset auditing/life cycle management
        which
        allows customers to minimize their overall IT expenditure and maximize their
        return on investment, IT asset remarketing for IT assets with market value
        and
        environmental compliance (proper recycling or safe disposal) for IT assets.
        The
        Company reduces its clients' potential liability by ensuring regulatory and
        environmental compliance for IT products. The Company's services are geared
        towards both the users of business-computing hardware (desktops, laptops,
        related peripherals and servers) as well as maintaining and providing services
        on enterprise-class hardware (mainframes, midrange servers, tape storage
        products and disk storage products).
 
 The
        Company purchases its products from a variety of sources, including Fortune
        1000
        companies, as well as leasing and finance companies, and re-sells
        a wide range of used and refurbished products, including mainframe processors
        and associated tape and disk products, connectivity products, midrange
        processors, laptop and desktop computers, monitors, processors, CD/DVD disk
        drives, modems, printers and memory. Only mainframe and associated peripherals
        that are manufactured by IBM are remarketed. The majority of the PC computers
        the Company sells are brand name Intel Pentium-class or equivalent products
        manufactured by IBM, Dell, Apple, Sony, Fujitsu, Hewlett-Packard, Toshiba
        and
        other major manufacturers.
 
 On
        May
        28, 2004, the Company purchased QualTech International Corporation and QualTech
        Services Group, Inc. QualTech International Corporation sells refurbished
        IBM
        mainframes and associated IBM peripherals to companies around the world.
        QualTech Services Group, Inc. provides hardware maintenance solutions and
        information systems consulting services to businesses in the United States.
 
 Page
            F-6
 
 **QSGI
          INC. AND SUBSIDIARIES**
 Notes
          To
          Consolidated Financial Statements*(Continued)*
  On
        October 17, 2005, the stockholders of the Company voted in favor of changing
        the
        Company name from Windsortech, Inc. to QSGI INC. The Company had employed
        QSGI
        as a trade name.
 
 The
        Company has office and warehouse space in Hightstown, New Jersey and Eagan,
        Minnesota, and satellite sales and business development offices in Colorado,
        Connecticut, Florida, Illinois, Maine, Michigan, New York, North Carolina,
        Nebraska, New Hampshire, Pennsylvania, South Carolina, Texas, Virginia,
        Wisconsin, and Wyoming.
 
 **Principles
        Of Consolidation**
  The
        financial statements include the accounts of the Company and its wholly owned
        subsidiaries. All significant inter-company accounts and transactions have
        been
        eliminated in consolidation.
 
 **Estimates**
  The
        preparation of financial statements in conformity with accounting principles
        generally accepted in the United States of America requires management to
        make
        estimates and assumptions that affect the reported amounts of assets and
        liabilities and disclosure of contingent assets and liabilities at the date
        of
        the financial statements and the reported amounts of revenues and expenses
        during the reporting period. Actual results could differ from those
        estimates.
 
 **Reclassifications**
  For
        financial presentation purposes, certain 2005 balances have been reclassified,
        where appropriate, to conform to the 2006 presentation.
 
 **Revenue
        Recognition**
  For
        product sales, the Company recognizes revenue at the time products are shipped
        and title is transferred, which is in accordance with the stated shipping
        terms.
        Revenue is recognized in accordance with these shipping terms so long as
        a
        purchase order, electronic, written or phone commitment has been received
        or a
        contract has been executed, there are no uncertainties regarding customer
        acceptance, the sales price is fixed and determinable and collectibility
        is
        deemed probable. If uncertainties exist regarding customer acceptance or
        collectibility, revenue is recognized when those uncertainties have been
        resolved. The Company provides a limited warranty on some of its products.
        The
        Company analyzes its estimated warranty costs and provides an allowance as
        necessary, based on experience. At December 31, 2006 and 2005, a warranty
        reserve was not considered necessary.
 
 Page
            F-7
 
  **QSGI
          INC. AND SUBSIDIARIES**
 Notes
          To
          Consolidated Financial Statements*(Continued)*
  Asset
        management fees are recognized once the services have been performed and
        the
        results reported to the client. In those circumstances where the Company
        disposes of the client’s product, or purchases the product from the client for
        resale, revenue is recognized as a “product sale” described above.
 
 Maintenance
        service revenue is recognized when the services are performed in accordance
        with
        the service agreement. Any prepaid service contracts are deferred and recognized
        over the term of the applicable agreements on a straight-line
        basis.
 
 **Cash
        And Cash Equivalents**
  The
        Company considers all liquid instruments purchased with maturity of three
        months
        or less to be cash equivalents.
 
 **Accounts
        Receivable**
  Accounts
        receivable are stated at the amount management expects to collect from
        outstanding balances. Management provides for probable uncollectible amounts
        through a charge to earnings and a credit to a valuation allowance based
        on its
        assessment of the current status of individual accounts. Balances which are
        still outstanding after management has used reasonable collection efforts
        are
        written off through a charge to the valuation allowance and a credit to trade
        accounts receivable.
 
 The
        allowance for doubtful accounts at December 31, 2006 and 2005, and changes
        in
        the allowance for the years then ended is as follows:
 
 **Balance
                  At**
              
              **Provision**
              
              **Write-Offs,**
              
              **Balance****Beginning**
              
              **For
                  Doubtful**
              
              **Net
                  Of**
              
              **At
                  End****Year**
              
              **Of
                  Year**
              
              **Accounts**
              
              **Recoveries**
              
              **Of
                  Year**2005
              
              $
              50,000
              
              $
              88,810
              
              $
              58,810
              
              $
              80,0002006
              
              
              80,000
              
              
              822,965
              
              
              122,849
              
              
              780,116
   Page
            F-8
 **QSGI
          INC. AND SUBSIDIARIES**
 Notes
          To
          Consolidated Financial Statements*(Continued)*
 **Inventories**
  Inventories
        consist primarily of computer hardware, parts and related products, and are
        valued at the lower of average cost or market. Substantially all inventory
        items
        are finished goods. The allocated cost of parts disassembled from purchased
        computer hardware is based on the relative fair value of the disassembled
        components. The allocation of cost does not exceed the original cost of the
        computer hardware. The Company closely monitors and analyzes inventory for
        potential obsolescence and slow-moving items on an item-by-item basis. Inventory
        items determined to be obsolete or slow moving are reduced to net realizable
        value. Inventory in-transit consists of items of inventory for which the
        Company
        has purchased and assumed the risk of loss, but which has not yet been received
        into stock at the Company’s facility.
 
 **Property
        And Equipment**
  Property
        and equipment is stated at cost, net of accumulated depreciation. Expenditures
        for maintenance and repairs are charged of operations as incurred. Upon
        retirement or sale, any assets disposed are removed from the accounts and
        any
        resulting gain or loss is reflected in the results of operations.
 
 Property,
        equipment, leasehold improvements, computer hardware and software are
        depreciated or amortized using the straight-line method over two to five-year
        periods. Capitalized values of property under leases are amortized over the
        life
        of the lease or the estimated life of the asset, whichever is less.
 
 Impairment
        losses on long-lived assets, such as equipment and improvements, are recognized
        when events or changes in circumstances indicate that the undiscounted cash
        flows estimated to be generated by such assets are less than their carrying
        value and, accordingly, all or a portion of such carrying value may not be
        recoverable. Impairment losses are then measured by comparing the fair value
        of
        assets to their carrying amounts.
 
 **Deposits**
  Deposits
        principally consist of the lease deposit for the Company’s New Jersey facility.
        This deposit is refundable at the expiration of the lease. Since the lease
        term
        extends beyond 12 months, the deposit is classified as a long-term asset
        in
        other assets on the balance sheet.
 
 **Advertising
        Costs**
  Advertising
        costs are expensed on the first date the advertisement takes place. Advertising
        expense amounted to $50,486 in 2006 and $259,966 in 2005.
  Page
            F-9
 **QSGI
          INC. AND SUBSIDIARIES**
 Notes
          To
          Consolidated Financial Statements*(Continued)*
 **Income
        Taxes**
  Deferred
        tax assets and liabilities are recognized for the future tax consequences
        attributable to the differences between the financial statement carrying
        amounts
        of existing assets and liabilities and their respective tax bases. Deferred
        tax
        assets and liabilities are measured using enacted tax rates expected to apply
        to
        taxable income in the years in which those temporary differences are expected
        to
        be recovered or settled. The effect on deferred tax assets and liabilities
        of a
        change in tax rates is recognized in income in the period that includes the
        enactment date. A valuation allowance is provided against net deferred tax
        assets where the Company determines realization is not currently judged to
        be
        more likely than not.
 
 **Loss
        Per Share**
  Basic
        loss per share is computed on the basis of the weighted average number of
        common
        share outstanding. Diluted loss per share is computed on the basis of the
        weighted average number of common shares outstanding plus the effect of all
        dilutive potential common shares that were outstanding during the period.
 
 The
        following table presents the computation of basic and diluted net loss per
        share:
 **2006**
              
              2005Net
                  loss available to common stockholders
              
              **$**
              **(758,682**
              **)**
              $
              (1,270,131
              )Determination
                  of basic and diluted shares:Basic
                  weighted average shares outstanding
              
              
              **30,127,255**
              
              
              28,132,778Effect
                  of dilutive securities:Stock
                  options
              
              
              —
              
              
              —Stock
                  warrants
              
              
              —
              
              
              —Diluted
                  weighted average shares outstanding
              
              
              **30,127,255**
              
              
              28,132,778Net
                  Loss Per Common Share - Basic
              
              $
              (0.03
              )
              $
              (0.05
              )Net
                  Loss Per Common Share - Diluted
              
              $
              (0.03
              )
              $
              (0.05
              )
 
 In
        2006,
        the Company excluded 1,104,348 weighted average common share equivalents
        related
        to stock options, and 1,911,111 weighted average common share equivalents
        related to convertible preferred stock because their effect would have been
        anti-dilutive.
  Page
            F-10
  **QSGI
          INC. AND SUBSIDIARIES**
 Notes
          To
          Consolidated Financial Statements*(Continued)*
 In
        2005,
        the Company excluded 1,638,961 weighted average common share equivalents
        related
        to stock options, 653,101 weighted average common share equivalents related
        to
        stock warrants and 62,831 weighted average common share equivalents related
        to
        convertible preferred stock because their effect would have been
        anti-dilutive.
 
 **Fair
        Value Of Financial Instruments**
  The
        carrying amounts of financial instruments including cash and cash equivalents,
        accounts receivable and accounts payable approximate fair value due to the
        relatively short maturity of these instruments. The carrying value of the
        notes
        payable and capital lease obligations, including the current portion,
        approximate fair value based on the incremental borrowing rates currently
        available to the Company for financing with similar terms and
        maturities.
 
 **Stock-Based
        Compensation**
  In
        December 2004, the FASB issued Statement of Financial Accounting Standards
        (SFAS) No. 123R, Share-Based Payment. SFAS No. 123R requires measurement
        of all
        employee stock-based compensation awards using a fair value method and the
        recording of such expense in the consolidated financial statements. In addition,
        the adoption of SFAS No. 123R requires additional accounting related to the
        income tax effects and additional disclosure regarding the cash flow effects
        resulting from share-based payment arrangements. Effective January 1, 2006,
        the
        Company adopted SFAS No. 123R using the modified prospective method.
  The
        Company previously accounted for stock-based employee compensation arrangements
        in accordance with the provisions of Accounting Principles Board (APB) Opinion
        No. 25, *Accounting
        for Stock Issued to Employees* ,
        and
        complies with the disclosure provisions of SFAS No. 123, *Accounting
        for Stock-Based Compensation* .
        Under
        APB Opinion No. 25, compensation cost is recognized over the vesting period
        based on the difference, if any, on the date of grant between the fair value
        of
        the Company’s stock and the amount an employee must pay to acquire the stock.
   Page
            F-11
 **QSGI
          INC. AND SUBSIDIARIES**
 Notes
          To
          Consolidated Financial Statements*(Continued)*
 Had
        compensation cost for these plans been determined based on the fair value
        at the
        grant dates for awards under these plans, consistent with the alternative
        method
        set forth under SFAS No. 123, the Company’s expense for the year ended December
        31, 2005 would have increased. The pro forma amounts are indicated
        below:
  2005Net
                  loss available to commonstockholders,
                  as reported
              
              $
              (1,270,131
              )Add:
                  Stock-based employee compensationexpense
                  included in reported netloss,
                  net of related tax effects
              
              
              37,414Deduct:
                  Total stock-based employeecompensation
                  expense determined underfair
                  value based method for all awards, netof
                  related tax effects
              
              
              (7,113,013
              )Proforma
                  net loss available tocommon
                  stockholders
              
              $
              (8,345,730
              )Loss
                  per share:Basic
                  - as reported
              
              $
              (0.05
              )Diluted
                  - as reported
              
              $
              (0.05
              )Basic
                  - Proforma
              
              $
              (0.30
              )Diluted
                  - Proforma
              
              $
              (0.30
              )
 
 The
        weighted average per share fair value of the options granted was $1.43 and
        $2.02
        for the years ended December 31, 2006 and 2005, respectively. The fair value
        of
        each option granted is estimated on the date of grant using the Black-Scholes
        option-pricing model with the following weighted-average
        assumptions:
 
 **2006**
              
              2005Risk-free
                  interest rates
              
              
              4.59%
              
              
              4.14%Expected
                  option lives
              
              
              5
                  years
              
              
              5
                  yearsExpected
                  volatilities
              
              
              75%
              
              
              96%Expected
                  dividend yields
              
              
              —%
              
              
              —%
   Page
            F-12
 **QSGI
          INC. AND SUBSIDIARIES**
 Notes
          To
          Consolidated Financial Statements*(Continued)*
 **Impact
        Of Recently Issued Accounting Standards**
  In
        September 2006, the Securities and Exchange Commission issued Staff Accounting
        Bulletin (SAB) No. 108, *Considering
        the Effects of Prior Year Misstatements when Quantifying Current Year
        Misstatements.* SAB
        No. 108 requires analysis of misstatements using both an income statement
        (rollover) approach and a balance sheet (iron curtain) approach in assessing
        materiality and provides for a one-time cumulative effect transition
        adjustment. SAB No. 108 is effective for fiscal years ending after November
        15, 2006. The adoption of SAB No. 108 did not have an impact on the company's
        financial position or results of operations.
 
 In
        September 2006, the FASB issued SFAS No. 157, *Fair
        Value Measurements,* which
        defines fair value, establishes a framework for measuring fair value in
        generally accepted accounting principles, and expands disclosures about fair
        value measurements. SFAS No. 157 does not require any new fair value
        measurements, but provides guidance on how to measure fair value by providing
        a
        fair value hierarchy used to classify the source of the information. This
        statement is effective for the Company beginning January 1, 2008. The Company
        is
        currently assessing the potential impact that adoption of SFAS No. 157 will
        have on its financial statements.
  In
        June
        2006, the FASB issued FASB Interpretation (FIN) No. 48, *Accounting
        for Uncertainty in Income Taxes - an interpretation of FASB Statement
        No. 109,* which
        clarifies the accounting for uncertainty in income taxes recognized in an
        enterprise’s financial statements in accordance with FASB Statement
        No. 109, *Accounting
        for Income Taxes.* The
        interpretation prescribes a recognition threshold and measurement attribute
        for
        the financial statement recognition and measurement of a tax position taken
        or
        expected to be taken in a tax return. FIN No. 48 requires recognition of
        tax benefits that satisfy a greater than 50% probability threshold. FIN
        No. 48 also provides guidance on derecognition, classification, interest
        and penalties, accounting in interim periods, disclosure, and transition.
        FIN
        No. 48 is effective for the Company beginning January 1, 2007. The Company
        is currently assessing the potential impact that adoption of FIN No. 48
        will have on its financial statements.
  
 Page
            F-13
 **QSGI
          INC. AND SUBSIDIARIES**
 Notes
          To
          Consolidated Financial Statements*(Continued)*
 
 **2.**
              **Inventories**
 
 Inventories
        consist of:
 **2006**
              
              2005Finished
                  goods
              
              **$**
              **4,810,843**
              
              $
              3,144,515Inventory
                  in transit
              
              
              **246,867**
              
              
              1,041,789Allowance
                  for excess and obsolescence
              
              
              **(75,000**
              **)**
              
              (50,000
              )**$**
              **4,982,710**
              
              $
              4,136,304
 
 
 **3.**
              **Property
                  And Equipment**
 
 Property
        and equipment consist of:
 **2006**
              
              2005Furniture
                  and fixtures
              
              **$**
              **152,384**
              
              $
              140,143Equipment
              
              
              **458,537**
              
              
              451,822Leasehold
                  improvements
              
              
              **92,862**
              
              
              69,523Computer
                  equipment and software
              
              
              **610,004**
              
              
              514,814**1,313,787**
              
              
              1,176,302Less:
                  Accumulated depreciation
              
              
              **903,546**
              
              
              570,415**$**
              **410,241**
              
              $
              605,887
 
 Depreciation
        and amortization charged against income for all property and equipment amounted
        to $341,100 and $298,327 for the years ended December 31, 2006 and 2005,
        respectively.
    Page
            F-14
 **QSGI
          INC. AND SUBSIDIARIES**
 Notes
          To
          Consolidated Financial Statements*(Continued)*
 **4.**
              **Business
                  Acquisitions**
 
 In
        May
        2004, the Company completed the purchase of all of the outstanding shares
        of
        QualTech International Corporation and its affiliate, QualTech Services Group,
        Inc., (collectively “QualTech”). QualTech International Corporation is a
        worldwide re-seller of refurbished IBM mainframes and associated IBM
        peripherals. QualTech Services Group, Inc. provides hardware maintenance
        solutions and information systems consulting services to businesses in the
        United States. The Company’s primary reasons for the acquisition of QualTech
        were to expand the Company’s product offerings to include mainframe hardware and
        mainframe hardware services, to acquire an existing Fortune 1000 customer
        base
        to allow the Company to market its current product offerings to these customers
        and to acquire a leader in its industry with talented personnel to enhance
        the
        Company’s expertise. The acquisition was accounted for using the purchase method
        of accounting, and the results of operations of the acquired companies are
        included from the effective acquisition date of May 1, 2004.
 
 The
        initial cost of the acquired entities of $6,686,520 included payments to
        QualTech’s shareholders of $6,586,520 of which $3,336,520 was in cash and
        $3,250,000 was in the Company’s common stock. The value of the Company’s stock
        was based on its average market value several days prior to the acquisition.
        Direct acquisition costs, consisting primarily of legal fees, were
        $100,000.
 
 In
        addition to the initial purchase price described in the previous paragraph,
        additional contingent consideration was due on May 1, 2006, based on QualTech
        meeting certain objectives. QualTech selling shareholders were entitled to
        receive 5.5 times the average income after taxes that exceeded $1,100,000,
        for
        the two-year period following the effective date of the merger. The selling
        shareholders were entitled to the additional merger consideration in the
        form of
        restricted shares of the Company. These restricted shares were to represent
        at
        least fifty percent (50%) of the additional consideration due and cash of
        up to
        fifty percent (50%) of the additional consideration. This ratio was to be
        determined at the discretion of the Company. Any portion that was to be paid
        in
        cash was due within 30 days following the second anniversary of the effective
        date of the acquisition. The number of shares paid in stock was due on February
        15, 2007. The number of shares due was to be determined by using the average
        trading price 15 days prior to February 14, 2007.
 
 The
        Company elected to pay the consideration early in restricted shares of the
        Company. To settle the additional consideration, 2,063,545 shares were issued
        at
        a value of approximately $1.66 per share resulting in additional goodwill
        in the
        amount of $3,432,089.
    Page
            F-15
 **QSGI
          INC. AND SUBSIDIARIES**
 Notes
          To
          Consolidated Financial Statements*(Continued)*
 The
        allocation of the aggregate purchase price was performed with the assistance
        of
        an independent valuation firm. The purchase price allocation identified
        $3,400,000 of intangible assets other than goodwill. The total goodwill
        recognized amounted to $6,644,403. Goodwill recorded in connection with this
        acquisition will not be amortized to expense, but will be subject to periodic
        testing for impairment in accordance with SFAS No 142, *Goodwill
        and Other Intangible Assets* .
        None of
        this goodwill is expected to be deductible for tax purposes.
 
 The
        fair
        value of the net assets of QualTech that were acquired is as
        follows:
 
 Cash
              
              $
              345,281Accounts
                  receivable
              
              
              1,293,708Inventory
              
              
              824,625Fixed
                  assets
              
              
              262,617Other
                  assets
              
              
              35,393Intangible
                  assets
              
              
              3,400,000Goodwill
              
              
              6,644,403Accounts
                  payable
              
              
              (603,480
              )Accrued
                  expenses
              
              
              (129,927
              )Short-term
                  debt
              
              
              (510,000
              )Deferred
                  tax liability
              
              
              (1,179,647
              )Other
                  liabilities
              
              
              (264,364
              )$
              10,118,609
   Page
            F-16
 **QSGI
          INC. AND SUBSIDIARIES**
 Notes
          To
          Consolidated Financial Statements*(Continued)*
 
 
 **5.**
              **Goodwill
                  And Other Intangible
                  Assets**
 
 In
        accordance with the SFAS No. 142, *Goodwill
        and Other Intangible Assets* ,
        the
        Company is required to assess goodwill and indefinite-lived intangible assets
        for impairment annually, or more frequently if circumstances indicate impairment
        may have occurred. The Company’s reporting units are the same as its reportable
        business segments. Goodwill was assigned to the Data Center Hardware and
        Data
        Center Maintenance reporting units at their acquisition. The Company performed
        impairment tests in the fourth quarter of 2006 and 2005, and has determined
        that
        the carrying value of such assets were not impaired as of those dates. Goodwill
        increased during 2006 due to the additional merger consideration payment
        of
        $3,432,089. At December 31, 2006 and 2005, the balance of goodwill and
        intangible assets are as follows:
 
 **2006**
              
              2005Goodwill
              
              **$**
              **6,644,403**
              
              $
              3,212,314Intangible
                  assets with indefinite lives
              
              
              **910,000**
              
              
              910,000Intangible
                  assets with definite lives, net
              
              
              **1,645,584**
              
              
              1,962,240**$**
              **9,199,987**
              
              $
              6,084,554
  Intangible
        assets with indefinite lives relate principally to trade names. Intangibles
        with
        definite lives relate principally to the following:
 
 **2006**
              
              **Accumulated**
              
              
              
              **Amortization****Cost**
              
              **Amortization**
              
              **Amortization**
              
              **Net**
              
              **Life
                  (Years)**Customer
                  Lists
              
              $
              1,640,000
              
              $
              182,208
              
              $
              485,888
              
              $
              1,154,112
              
              
              9.0Database
              
              
              400,000
              
              
              44,448
              
              
              118,528
              
              
              281,472
              
              
              9.0Employee
                  Non-competes
              
              
              450,000
              
              
              90,000
              
              
              240,000
              
              
              210,000
              
              
              5.0Total
              
              $
              2,490,000
              
              $
              316,656
              
              $
              844,416
              
              $
              1,645,584
    Page
            F-17
 **QSGI
          INC. AND SUBSIDIARIES**
 Notes
          To
          Consolidated Financial Statements*(Continued)*
 **2005**
              
              **Accumulated**
              
              
              
              **Amortization****Cost**
              
              **Amortization**
              
              **Amortization**
              
              **Net**
              
              **Life
                  (Years)**Customer
                  Lists
              
              $
              1,640,000
              
              $
              182,208
              
              $
              303,680
              
              $
              1,336,320
              
              
              9.0Database
              
              
              400,000
              
              
              44,448
              
              
              74,080
              
              
              325,920
              
              
              9.0Employee
                  Non-
                competes
              
              
              450,000
              
              
              90,000
              
              
              150,000
              
              
              300,000
              
              
              5.0Total
              
              $
              2,490,000
              
              $
              316,656
              
              $
              527,760
              
              $
              1,962,240
 
 Amortization
        of intangible assets is computed on a straight-line basis and based on December
        31, 2006 balances, expected
        amortization expense in each of the next five years is as follows:
 
 **Year**
              
              **Amount**2007
              
              $
              316,6562008
              
              
              316,6562009
              
              
              256,6562010
              
              
              226,6562011
              
              
              226,656$
              1,343,280
 
 
 **6.**
              **Other
                  Assets**
 
 Other
        assets consist of:
 **2006**
              
              2005Deposits
              
              **$**
              **78,422**
              
              $
              76,972Trademark
              
              
              **7,885**
              
              
              7,885Patent,
                  net of amortization of $3,330 in2006
                  and $2,119 in 2005
              
              
              **20,886**
              
              
              22,097Deferred
                  loan costs
              
              
              **40,000**
              
              
              —Other
              
              
              **11,591**
              
              
              9,271**$**
              **158,784**
              
              $
              116,225
 
 The
        patent is being amortized over a 20-year life. Patent amortization expense
        in
        2006 amounted to $1,211 and in 2005 amounted to $706. Expected amortization
        expense in each of the next five years is approximately $1,211 per
        year.
 
 Page
            F-18
  **QSGI
          INC. AND SUBSIDIARIES**
 Notes
          To
          Consolidated Financial Statements*(Continued)*
 
 **7.**
              **Financing
                  Arrangements**
 
 **Revolving
        Lines Of Credit**
  On
        May 3,
        2005, the Company entered into a revolving line-of-credit agreement that
        provides for borrowings limited to the lesser of $4,250,000 or the borrowing
        base of 80% of eligible accounts receivable plus 40% of inventories and in
        certain circumstances 60% of eligible inventories, with eligible inventories
        not
        to exceed $1,500,000. Availability on the line of credit at December 31,
        2006
        was $334,175. Interest on this loan is payable monthly at the prime rate
        plus 1%
        (9.25% at December 31, 2006), with all principal and interest due April 1,
        2007.
        In accordance with Emerging Issues Task Force (EITF) Issue No. 95-22, the
        line
        of credit is classified as a current liability due to the agreement containing
        a
        subjective acceleration clause and a lock-box arrangement. All loans or lines
        of
        credit that the Company had prior to this date were repaid and cancelled.
 
 The
        revolving line-of-credit arrangement contains certain financial covenants,
        including maintaining a minimum tangible net worth, a minimum fixed charge
        coverage ratio, and limiting capital expenditures. The Company was in compliance
        with all of its covenants at December 31, 2006.
 
 On
        January 17, 2007, the Company paid off the May 3, 2005 revolving line-of-credit
        and entered into a revolving line-of-credit agreement with a different financial
        institution that provides for borrowings limited to the lesser of $7,500,000
        or
        the borrowing base of 85% of eligible accounts receivable plus 45% of
        inventories, with eligible inventories not to exceed $3,000,000. The new
        revolving line-of-credit agreement contains certain financial covenants,
        including minimum net income requirements as follows:
  **Year
                  To Date****Quarterly
                  Net**
              
              **Net
                  Income****Period
                  Ending**
              
              **Income
                  (Loss)**
              
              **(Loss)**March
                  31, 2007
              
              $
              (250,000
              )
              $
              (250,000
              )June
                  30, 2007
              
              
              500,000
              
              
              250,000September
                  30, 2007
              
              
              150,000
              
              
              400,000December
                  31, 2007
              
              
              400,000
              
              
              800,000March
                  31, 2008
              
              
              100,000
              
              
              100,000June
                  30, 2008
              
              
              200,000
              
              
              300,000September
                  30, 2008
              
              
              200,000
              
              
              500,000December
                  31, 2008
              
              
              300,000
              
              
              800,000March
                  31, 2009
              
              
              100,000
              
              
              100,000June
                  30, 2009
              
              
              200,000
              
              
              300,000September
                  30, 2009
              
              
              200,000
              
              
              500,000December
                  31, 2009
              
              
              300,000
              
              
              800,000
   Page
            F-19
  **QSGI
          INC. AND SUBSIDIARIES**
 Notes
          To
          Consolidated Financial Statements*(Continued)*
  If
        the
        Company is unable to achieve these covenants on a quarterly basis, it
        will **** be
        considered to be in default of the line-of-credit agreement. If the Company
        is
        in default, the lender has the right to terminate the agreement, causing
        all
        amounts to become immediately due and payable.
 
 If
        the
        Company were to be in default under its line-of-credit agreement, it could
        pursue certain options, such as negotiating new terms with the financial
        institution. However, there can be no guarantee that the Company would be
        able
        to negotiate new agreements. Additionally, if the Company were to be successful
        in negotiating new agreements, they could be on terms that are less favorable
        to
        the Company than the current line-of-credit agreement.
 
 **8.**
              **Redeemable
                  Convertible Preferred Stock**
 
 In
        December 2005, the Company completed a private placement with a group of
        investors for net proceeds of approximately $4,200,000. The Company received
        the
        proceeds in two payments. The first payment, net of offering costs, of
        $1,967,220 was received at the time of signing and $2,236,301 was received
        at
        the beginning of January 2006.
 
 The
        preferred securities issued in the private placement consist of 143,333 shares
        of 6% Series A Preferred Stock with a face value of $30 per share. The 6%
        dividend is payable quarterly in cash or additional preferred securities
        at the
        Company’s option. Each Series A Preferred Share is convertible into
        approximately 13.33 shares of the Company’s common stock. The Company can
        require the holders to convert the shares if the Company’s common stock price
        maintains $2.75 for twenty consecutive business days. The Company can redeem
        the
        preferred securities at any time after December 10, 2007. Additionally, the
        holder may demand redemption in cash, for the original $30 per share, at
        any
        time after December 10, 2010. Because these preferred securities are
        conditionally redeemable, they are classified as temporary equity in the
        balance
        sheet.
   Page
            F-20
 **QSGI
          INC. AND SUBSIDIARIES**
 Notes
          To
          Consolidated Financial Statements*(Continued)*
 
 **9.**
              **Stockholders’
                  Equity**
 
 **Stock
        Option Grants**
  In
        October 2001, the Company granted 1,350,000 options to its shareholders and
        employees to acquire shares of its common stock at $0.026 per common share
        pursuant to individual option grants. The terms of the grants provided for
        immediate vesting, and the options may be exercised at any time for a period
        of
        ten years commencing October 1, 2001.
 
 In
        January 2002, the Company’s stockholders approved the 2002 Flexible Stock Plan
        (the “2002 Plan”). Under the 2002 Plan, the number of shares which may be issued
        or sold, or for which options, stock appreciation rights (SAR’s) or performance
        shares may be granted to certain directors, officers and employees of the
        Company is 5,000,000, plus an annual increase, effective the first day of
        each
        calendar year, commencing on January 1, 2003, equal to 10% of the number
        of
        shares outstanding as of the first day of such calendar year but in no event
        more than 30,000,000 shares in the aggregate.
 
 On
        December 28, 2005, the Company’s Board of Directors approved a resolution that
        provided for the immediate accelerated vesting on December 28, 2005 of the
        majority of the Company’s outstanding and unvested stock options previously
        awarded to employees and directors.
 
 The
        purpose of accelerating the vesting of the employees’ and directors’ options was
        to enable the Company to avoid recognizing in its statement of operations
        compensation expense associated with the options in future periods. As a
        result
        of the acceleration, the Company expects to avoid recognition, on an after
        tax
        basis, of up to approximately $426,000 of compensation expense in its statement
        of operations over the course of the original vesting period, substantially
        all
        of which is expected to be avoided in 2006 and 2007. Such expense is included
        in
        the Company’s proforma stock-based compensation footnote disclosure for the year
        ended December 31, 2005.
 
 Stock
        option compensation expense in the amount of $18,184 and $61,334 was recorded
        in
        2006 and 2005, respectively. The expense recorded in 2005 included the effects
        of the acceleration of certain stock options.
   Page
            F-21
 **QSGI
          INC. AND SUBSIDIARIES**
 Notes
          To
          Consolidated Financial Statements*(Continued)*
 
 A
        summary
        of stock option activity is as follows:
 
 **2006**
              
              2005**Weighted-**
              
              
              
              Weighted-**Average**
              
              
              
              Average**Exercise**
              
              
              
              Exercise**Shares**
              
              **Price**
              
              Shares
              
              PriceOutstanding
                  - beginning of period
              
              
              **12,566,834**
              
              **$**
              **1.918**
              
              
              8,725,000
              
              $
              1.170Granted
              
              
              **30,000**
              
              
              **1.430**
              
              
              6,042,500
              
              
              2.713Exercised
              
              
              **(350,000**
              **)**
              
              **0.026**
              
              
              (1,801,666
              )
              
              0.699Forfeited
              
              
              **(25,000**
              **)**
              
              **1.540**
              
              
              (399,000
              )
              
              3.103Outstanding
                  on December 31
              
              
              **12,221,834**
              
              **$**
              **1.972**
              
              
              12,566,834
              
              $
              1.918Exercisable
                  on December 31
              
              
              **12,165,167**
              
              **$**
              **1.973**
              
              
              12,503,500
              
              $
              1.919
 
 Unrecognized
        stock option compensation cost related to unvested stock options amounts
        to
        approximately $50,000. The cost is expected to be recognized over the next
        five
        years.
  The
        following table summarizes information about the options outstanding at December
        31, 2006:
 **Outstanding**
              
              **Exercisable****Stock
                  Options**
              
              **Stock
                  Options****Weighted-****Average**
              
              **Weighted-**
              
              
              
              **Weighted-****Range
                  Of**
              
              
              
              **Remaining**
              
              **Average**
              
              
              
              **Average****Exercise**
              
              
              
              **Contractual**
              
              **Exercise**
              
              
              
              **Exercise****Prices**
              
              **Shares**
              
              **Life**
              
              **Price**
              
              **Shares**
              
              **Price**$
                  0.026
              
              
              1,740,000
              
              
              5.1
              
              $
              0.026
              
              
              1,740,000
              
              $
              0.0261.43
                  to 1.90
              
              
              2,718,334
              
              
              7.5
              
              
              1.676
              
              
              2,661,667
              
              
              1.6762.00
                  to 2.13
              
              
              2,315,000
              
              
              7.7
              
              
              2.008
              
              
              2,315,000
              
              
              2.0082.50
                  to 2.75
              
              
              5,025,000
              
              
              7.9
              
              
              2.664
              
              
              5,025,000
              
              
              2.6643.45
                  to 3.46
              
              
              423,500
              
              
              4.0
              
              
              3.450
              
              
              423,500
              
              
              3.45012,221,834
              
              
              
              
              
              
              
              
              12,165,167
   Page
            F-22
 **QSGI
          INC. AND SUBSIDIARIES**
 Notes
          To
          Consolidated Financial Statements*(Continued)*
 
 **Warrants**
  In
        May
        2004, the Company issued 6,000,000 warrants to a group of investors in
        connection with the sale of 6,000,000 shares of common stock. 3,000,000 of
        the
        warrants are exercisable for a period of five years at a price of $1.50 per
        share and 3,000,000 of the warrants are exercisable for a period of five
        years
        at a price of $3.60 per share. These warrants were valued at $1,521,261,
        based
        on the relative fair value of the warrants as compared to the common stock
        issued.
 
 In
        October 2004, the Company issued 350,000 warrants with an exercise price
        of
        $2.00 to certain warrant holders in exchange for their exercise of 500,000
        warrants for which the Company received $750,000. The fair value of the 350,000
        new warrants plus the fair value of the 500,000 warrants with a decreased
        exercise period was less than the fair value of the 500,000 warrants before
        the
        modification. As such, no value was assigned to the new warrants.
 
 In
        December 2005, the Company completed the repurchase and retirement of 4,283,334
        outstanding warrants, including 1,866,667 warrants exercisable at $1.50 per
        share and 2,416,667 warrants exercisable at $3.60 per share. The total purchase
        price for the warrants, including transaction costs, was $1,256,210 in cash.
        These warrants, previously held by an institutional investor, were issued
        as
        part of the private placement that was completed in May 2004.
 
 A
        schedule of common stock warrant activity is as follows:
 
 **Weighted-****Number**
              
              **Average****Of**
              
              **Exercise****Shares**
              
              **Price**Outstanding
                  at December 31, 2004
              
              
              6,450,000
              
              $
              2.43Warrants
                  repurchased and cancelled
              
              
              (4,283,334
              )
              
              2.52Warrants
                  exercised
              
              
              (1,233,333
              )
              
              0.28Outstanding
                  at December 31, 2005
              
              
              933,333
              
              
              3.00Warrants
                  issued
              
              
              —
              
              
              —Warrants
                  exercised
              
              
              —
              
              
              —Outstanding
                  at December 31, 2006
              
              
              933,333
              
              $
              3.00
   Page
            F-23
 **QSGI
          INC. AND SUBSIDIARIES**
 Notes
          To
          Consolidated Financial Statements*(Continued)*
 
 The
        following table summarizes information about the warrants outstanding at
        December 31, 2006:
 **Outstanding
                  Stock Warrants**
              
              **Exercisable
                  Warrants****Weighted-****Average**
              
              **Weighted-**
              
              
              
              **Weighted-****Remaining**
              
              **Average**
              
              
              
              **Average****Exercise**
              
              
              
              **Contractual**
              
              **Exercise**
              
              
              
              **Exercise****Prices**
              
              **Number**
              
              **Life**
              
              **Price**
              
              **Shares**
              
              **Price**$
                  2.00
              
              
              350,000
              
              
              .83
              
              $
              2.00
              
              
              350,000
              
              $
              2.003.60
              
              
              583,333
              
              
              2.38
              
              
              3.60
              
              
              583,333
              
              
              3.60933,333
              
              
              
              
              
              
              
              
              933,333
 
 
 **10.**
              **Income
                  Taxes**
 
 The
        benefit for income taxes consists of the following:
 
 **2006**
              
              2005Current
              
              **$**
              **29,313**
              
              $
              219Deferred
              
              
              **(271,686**
              **)**
              
              (760,465
              )**$**
              **(242,373**
              **)**
              $
              (760,246
              )
    Page
            F-24
 **QSGI
          INC. AND SUBSIDIARIES**
 Notes
          To
          Consolidated Financial Statements*(Continued)*
 The
        tax
        effects of temporary differences and carryforwards that give rise to significant
        portions of deferred tax assets and liabilities consist of the
        following:
 
 **2006**
              
              2005**Deferred
                  Tax Assets**Liabilities
                  and reserves
              
              **$**
              **356,220**
              
              $
              79,779Net
                  operating loss carryforwards
              
              
              **1,499,268**
              
              
              1,727,560Stock
                  options
              
              
              **36,732**
              
              
              29,640Inventory
                  capitalization
              
              
              **129,585**
              
              
              106,205Property
                  and equipment
              
              
              **31,526**
              
              
              —**2,053,331**
              
              
              1,943,184****Valuation
                  Allowance
              
              
              **(873,183**
              **)**
              
              (873,183
              )**1,180,148**
              
              
              1,070,001**Deferred
                  Tax Liabilities**Property
                  and equipment
              
              
              **—**
              
              
              35,445Prepaid
                  expenses
              
              
              **28,113**
              
              
              30,317Patent
                  and trademark
              
              
              **8,321**
              
              
              8,715Intangibles
              
              
              **996,678**
              
              
              1,120,174**1,033,112**
              
              
              1,194,651**Net
                  Deferred Tax Liability**
              
              **$**
              **147,036**
              
              $
              (124,650
              )
 
 The
        current and long-term components of the net deferred tax liability are as
        follows:
 
 **2006**
              
              2005Current
                  deferred tax asset
              
              **$**
              **598,661**
              
              $
              72,094Long-term
                  deferred tax liability
              
              
              **(451,625**
              **)**
              
              (196,744
              )**$**
              **147,036**
              
              $
              (124,650
              )
 
 The
        reconciliation of the effective tax rate with the statutory federal income
        tax
        benefit rate is as follows:
   **2006**
              
              **2005**Statutory
                  federal rate
              
              
              **34**
              **%**
              
              34
              %State
                  income taxes, net of federal benefits
              
              
              **1**
              
              
              5Meals,
                  entertainment and club dues
              
              
              **(2**
              **)**
              
              (1
              )**33**
              **%**
              
              38
              %
    Page
            F-25
 **QSGI
            INC. AND SUBSIDIARIES**
 Notes
            To
            Consolidated Financial Statements*(Continued)*
 In
        the
        second quarter of 2006, during preparation of the Company’s federal income tax
        return for the year ended December 31, 2005, it was discovered that certain
        compensation deductions related to the exercise of stock options, totaling
        approximately $2,300,000, were excluded from the Company’s tax provision
        prepared at December 31, 2005.
  The
        impact of these additional deductions was to increase the deferred tax asset
        by
        approximately $870,000. The Company determined that, had these facts been
        known
        during the original preparation of the tax provision for the year ended December
        31, 2005, a valuation allowance would have been provided against these
        additional deferred tax assets. Should the Company determine in the future
        that
        the deferred tax asset valuation allowance should be reversed, it will result
        in
        an increase to additional paid-in capital, with no impact on the tax
        provision.
 
 At
        December 31, 2006, the Company had approximately $4,400,000 of net operating
        loss carry forward for federal income tax purposes that will begin to expire
        on
        December 31, 2022. The utilization of these net operating losses may be limited
        as to use in any particular year by the provision of Internal Revenue Code
        Section 382.
 
 **11.**
              **Concentrations**
 
 **Major
        Customers**
  For
        the
        years ended December 31, 2006 and 2005, sales to the Company’s top ten customers
        comprised 44% and 37% of revenue, respectively. Sales to one of these customers
        comprised 11% and 4% of sales in 2006 and 2005, respectively. The Company’s top
        ten customers also comprised 51% and 51% of the accounts receivable balance
        at
        December 31, 2006 and 2005, respectively.
 
 **Purchases**
  The
        Company purchases a majority of its products from a small number of suppliers.
        Approximately 51% and 22% of product purchases were from three vendors for
        the
        years ended December 31, 2006 and 2005, respectively.
   Page
            F-26
 **QSGI
          INC. AND SUBSIDIARIES**
 Notes
          To
          Consolidated Financial Statements*(Continued)*
 
 **12.**
              **Benefit
                  Plan**
 
 The
        Company has a 401(k) defined contribution benefit plan for all eligible
        employees. The Company contributes 3% of eligible employees’ salaries to the
        plan. The Company contributed $63,327 and $59,399 to the plan during the
        years
        ended December 31, 2006, and 2005, respectively.
 
 
 **13.**
              **Commitments
                  And Contingencies**
 
 **Leases**
  The
        Company has two operating leases on New Jersey real property. One is a month
        to
        month lease and the other expires in the year 2011. In addition to fixed
        rentals, the real property lease on one property requires the Company to
        pay all
        maintenance, real estate taxes and insurance.
 
 The
        Company has an operating lease on New Hampshire real property expiring in
        the
        year 2007.
 
 The
        Company has an operating lease on Minnesota real property expiring in the
        year
        2009. In addition to fixed rentals, the real property lease requires the
        Company
        to pay its pro-rata share of all maintenance, real estate taxes, and
        insurance.
 
 The
        Company has an operating lease on New York real property expiring in the
        year
        2007.
 The
        Company has an operating lease on Florida real property expiring in the year
        2007.
 
 The
        Company has an operating lease on equipment expiring in the year
        2007.
 
 Rent
        expense and other charges totaled $782,979 and $621,356 for the years ended
        December 31, 2006 and 2005, respectively.
   Page
            F-27
 **QSGI
          INC. AND SUBSIDIARIES**
 Notes
          To
          Consolidated Financial Statements*(Continued)*
 
 The
        approximate minimum payments required under these operating leases at December
        31, 2006 are:
 
 **Year**
              
              **Amount**2007
              
              $
              634,0002008
              
              
              434,0002009
              
              
              331,0002010
              
              
              186,0002011
              
              
              142,000$
              1,727,000
 
 **Environmental**
  The
        Company recycles used equipment that may contain hazardous materials. The
        Company contracts with a licensed waste management company for the purpose
        of
        recycling or destruction of these materials in accordance with all applicable
        environmental standards. Therefore, management believes it is not necessary
        to
        record a liability for environmental contingencies in the accompanying financial
        statements.
 
 **Employment
        Contracts**
  In
        2005,
        the Company entered into employment contracts with three of its executive
        officers. Their contracts are initially for three-year terms. These contracts
        include "change of control" provisions, under which the employees may terminate
        their employment within one year after a change in control, and be entitled
        to
        receive specified severance payments generally equal to three times their
        ending
        average compensation for the preceding year. In addition, these employees
        could
        also receive these payments if they were involuntarily terminated without
        cause,
        even if there is no change in control.
 
 In
        2006,
        the Company entered into an employment contract with one of its executive
        officers. This contract is for approximately 11 months, automatically renewable
        for six month terms beginning February 14, 2007. After the expiration of
        the
        initial period the employee has the right to cease his employment by providing
        at least six (6) months advance written notice prior to the commencement
        of the
        next employment period.
   Page
            F-28
 **QSGI
          INC. AND SUBSIDIARIES**
 Notes
          To
          Consolidated Financial Statements*(Continued)*
 
 **Legal
        Proceedings**
  The
        Company is party to legal proceedings arising in the ordinary course of
        business. In the opinion of management, these proceedings are not likely
        to have
        a material adverse effect on the financial position, results of operations
        or
        cash flows of the Company. The estimate of potential impact on the Company
        could
        change in the future.
 
 
 **14.**
              **Related
                  Party Transactions**
 
 In
        2006
        and 2005, the Company had sales to one customer related to one stockholder
        and
        officer of the Company. Sales to such customer for the years ended
        December 31, 2006 and 2005 amounted to approximately $158,000 and $857,000,
        respectively. No accounts receivable from this customer was outstanding at
        December 31, 2006 or December 31, 2005.
 
 In
        2005,
        the Company signed a 24 month lease for a tractor trailer from Varilease
        Technology Finance Group, Inc., a company that is owned by one of the members
        of
        the Board of Directors. For the years ended December 31, 2006 and 2005, rent
        expense for this lease amounted to $179,585 and $55,522, respectively. No
        accounts payable due to this vendor was outstanding at December 31, 2006.
        Accounts payable to this vendor amounted to $41,218 at December 31, 2005.
 
 
 **15.**
              **Supplemental
                  Cash Flow Information**
 
 During
        2006, the Company issued 88,540 shares of its common stock for services rendered
        during 2006 with two vendors for $161,687. During 2005, the Company issued
        85,625 shares of its common stock to settle an accounts payable balance with
        a
        vendor for $129,500. During 2006, the Company issued 2,063,545 shares of
        its
        common stock valued at $3,432,089 as final payment for the acquisition of
        QualTech.
   Page
            F-29
 **QSGI
          INC. AND SUBSIDIARIES**
 Notes
          To
          Consolidated Financial Statements*(Continued)*
 
 **16.**
              **Segment
                  Information**
 
 As
        a
        result of the acquisition of QualTech, the Company began operating in three
        business segments: Data Security and Compliance, Data Center Hardware, and
        Data
        Center Maintenance. The overall concept that QSGI INC. employs in determining
        its operating segments is to present the results in a manner consistent with
        how
        the chief operating decision maker and executive management view the businesses,
        how the businesses are organized as to segment management, and the focus
        of the
        businesses with regards to the types of products and services offered and
        the
        target market.
 
 **Data
        Security And Compliance Segment**
  This
        segment provides data security and regulatory compliance services for
        end-of-life business-computing Information Technology (IT) assets. The Company
        offers a variety of solutions to companies whose business computing technologies
        (desktops, laptops, printers, and servers) have come to the end of their
        life
        cycle. These services include data erasure to Department of Defense standards
        for hard drives, asset auditing/life cycle management which allows customers
        to
        minimize their overall IT expenditure and maximize their return on investment,
        IT asset remarketing for IT assets with market value and environmental
        compliance (proper recycling or safe disposal) for IT assets. These services
        can
        be custom tailored to meet the customer's needs. This can be implemented
        at one
        client location or at multiple locations, onsite, at the Company's facilities
        or
        through the use of the Company's mobile audit and erasure truck.
 
 **Data
        Center Hardware Segment**
  This
        segment remarkets refurbished mainframe processors, midrange processors and
        associated peripherals including tape and disk products and connectivity
        products. The Company is one of the leading resellers of refurbished
        enterprise-class hardware and associated peripheral products to companies
        around
        the world.
   Page
            F-30
 **QSGI
          INC. AND SUBSIDIARIES**
 Notes
          To
          Consolidated Financial Statements*(Continued)*
 **Data
        Center Maintenance**
  This
        segment provides hardware maintenance services on enterprise-class hardware
        and
        associated peripheral products and Data Center consulting to companies in
        the
        United States.
 
 The
        accounting policies of the operating segments are the same as those described
        in
        the summary of significant accounting policies, with the following exceptions.
        Intersegment sales and transfers are generally accounted for as if the sales
        or
        transfers were to third parties at current market prices. The Data Security
        and
        Compliance segment charges management fees to the Data Center Hardware and
        Data
        Center Maintenance segments for certain corporate services. Management fees
        charged to the Data Center Hardware segment amounted to $480,000 and $480,000
        in
        2006 and 2005, respectively. Management fees charged to the Data Center
        Maintenance segment amounted to $660,000 and $480,000 in 2006 and 2005,
        respectively. These intersegment transactions have been eliminated in
        consolidation.
 
 **2006**
              
              2005**Revenues**Products
              
              **$**
              **41,111,420**
              
              $
              33,085,383Services
              
              
              **5,297,497**
              
              
              3,300,755**Total
                  Revenues**
              
              **$**
              **46,408,917**
              
              $
              36,386,138
 
 **Revenues**Data
                  Security And Compliance
              
              **$**
              **22,013,739**
              
              $
              14,922,002Data
                  Center Hardware
              
              
              **20,035,133**
              
              
              19,790,233Data
                  Center Maintenance
              
              
              **4,847,885**
              
              
              3,096,222Intersegment
                  Elimination
              
              
              **(487,840**
              **)**
              
              (1,422,319
              )**Consolidated
                  Total**
              
              **$**
              **46,408,917**
              
              $
              36,386,138
 **Income
                    (Loss) Before Provision****(Benefit)
                    For Income Taxes**Data
                    Security And Compliance
                
                **$**
                **(2,763,369**
                **)**
                $
                (3,772,488
                )Data
                    Center Hardware
                
                
                **775,849**
                
                
                1,063,892Data
                    Center Maintenance
                
                
                **1,259,910**
                
                
                682,164**Consolidated
                    Total**
                
                **$**
                **(727,610**
                **)**
                $
                (2,026,432
                )
  Page
            F-31
 **QSGI
          INC. AND SUBSIDIARIES**
 Notes
          To
          Consolidated Financial Statements*(Continued)*
  **2006**
              
              2005**Depreciation
                  And Amortization**Data
                  Security And Compliance
              
              **$**
              **225,516**
              
              $
              186,763Data
                  Center Hardware
              
              
              **397,358**
              
              
              385,820Data
                  Center Maintenance
              
              
              **62,342**
              
              
              61,431**Consolidated
                  Total**
              
              **$**
              **685,216**
              
              $
              634,014
 
 **Segment
                  Assets**Data
                  Security And Compliance
              
              **$**
              **8,879,411**
              
              $
              6,841,435Data
                  Center Hardware
              
              
              **12,669,721**
              
              
              10,319,668Data
                  Center Maintenance
              
              
              **2,629,689**
              
              
              1,249,236**Consolidated
                  Total**
              
              **$**
              **24,178,821**
              
              $
              18,410,339
 
 **Goodwill**Data
                  Security And Compliance
              
              **$**
              **—**
              
              $
              —Data
                  Center Hardware
              
              
              **5,154,782**
              
              
              2,957,193Data
                  Center Maintenance
              
              
              **1,489,621**
              
              
              255,121**Consolidated
                  Total**
              
              **$**
              **6,644,403**
              
              $
              3,212,314
 
 **Expenditures
                  For Property And****Equipment**Data
                  Security And Compliance
              
              **$**
              **127,087**
              
              $
              285,694Data
                  Center Hardware
              
              
              **16,564**
              
              
              62,842Data
                  Center Maintenance
              
              
              **10,077**
              
              
              3,941**Consolidated
                  Total**
              
              **$**
              **153,728**
              
              $
              352,477
 
 **Company
        Data By Geographic Segment**
  The
        Company operates solely in the United States and has no assets in foreign
        countries. All of the Company’s purchases and sales are denominated in US
        dollars. The Company has not recorded any foreign currency transaction gains
        or
        losses in 2006 or 2005.
 
 For
        the
        years ended December 31, 2006 and 2005, export sales comprised 14% and 7%
        of
        revenue, respectively.
   Page
            F-32
 **QSGI
          INC. AND SUBSIDIARIES**
 Notes
          To
          Consolidated Financial Statements*(Continued)*
  Revenue
          by Geographic Segment comprised:
 
 **2006**
              
              2005United
                  States
              
              **$**
              **40,024,087**
              
              $
              33,893,593Asia
              
              
              **1,824,038**
              
              
              422,870Middle
                  East
              
              
              **1,823,709**
              
              
              —Europe
              
              
              **219,608**
              
              
              589,690Africa
              
              
              **602,447**
              
              
              42,275United
                  Kingdom
              
              
              **935,473**
              
              
              188,067Canada
              
              
              **324,056**
              
              
              203,055Australia
              
              
              **12,825**
              
              
              —South
                  America
              
              
              **642,674**
              
              
              1,046,588**Consolidated
                  Total**
              
              **$**
              **46,408,917**
              
              $
              36,386,138
 
  
 Page
        F-32