UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549








FORM
10-K





[X]
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF


THE
SECURITIES EXCHANGE ACT OF 1934


For the
fiscal year ended December 31, 2007





[  ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF


THE
SECURITIES EXCHANGE ACT OF 1934


For the
transition period from ________ to ________







Commission
File No.:  001-32620





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)
835-9757


(Registrant's
Telephone Number)




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






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






Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.  Yes o No x






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






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






Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-X ( §229.405 of this chapter) is not contained herein, and will not
be contained, to the best of registrant's knowledge, definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K.x






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






Large
accelerated filer [ ]       Accelerated filer
[ ]        Non-accelerated filer [
]       Small Reporting Companyx
















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




The
aggregate market value of the common stock held by non-affiliates of the
Registrant as of June 29, 2007 (the business day of the Registrant’s most
recently completed second fiscal quarter), was $22,756,083 (31,172,716 shares x
$0.73 per share).




Number of
shares outstanding of the Registrant’s Common stock, as of March 1, 2008,
is 31,172,716.






A description of “Documents
Incorporated by Reference” is contained in Item 15 Exhibits and Financials
Statements.

















Table
      Of ContentsItem
            Description
            PagePart
      I1.
            Business
            11A.
            Risk
      Factors
            81B.
            Unresolved
      Staff Comments
            132.
            Property
            133.
            Legal
      Proceedings
            144.
            Submissions
      of Matters to a Vote of Security Holders
            14Part
      II5.
            Market
      for Registrant's Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities
            146.
            Selected
      Financial Data
            187.
            Management’s
      Discussion And Analysis of Financial Condition and Results of
      Operations
            187A.
            Quantitative
      and Qualitative Disclosures About Market Risk
            278.
            Financial
      Statements and Supplementary Data
            279.
            Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
            299A(T)
            Controls
      and Procedures
            299B.
            Other
      Information
            31Part
      III10.
            Directors,
      Executive Officers and Corporate Governance
            3111.
            Executive
      Compensation
            3412.
            Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
            4113.
            Certain
      Relationships and Related Transactions, and Director
      Independence
            4214.
            Principal
      Accountant Fees and Services
            44Part
      IV15.
            Exhibits,
      Financial Statement Schedules
            45Signatures
            46Financial
      Statements and Exhibits
            48















PART I




Item
1.                                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-K 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 and maintenance company.  Our Data Center
Maintenance and Hardware services as well as our Data Security and Compliance
services are geared towards both the users of enterprise-class hardware
(mainframes, midrange processors, large storage, controllers, etc.) as well as
the users of business-computing hardware (desktops, laptops, related peripherals
and servers).  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
      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.





B.
            Data
      Center Hardware





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





C.
            Data
      Security and 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 customers' 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.








2





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.





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.  We offer:





24/7/365
Call Center capabilities


"Call
Home" feature on hardware


Escalation
planning (customizable)


Industry-leading
field engineers backed by supervisory-level technical support


Comprehensive
inventory of whole systems and critical back-up parts


Upgrades,
features, add-ons in inventory


Preventive
maintenance


Current
patch and EC-level upgrades





Products
we maintain include:


-
            IBM
      mainframe products including z9 BC, z9 EC, z990, z890, z800, z900, 9672(G5
      & G6)


-
            IBM
      midrange products including pSeries, Sun and Hewlett
    Packard


-
            IBM/OEM
      tape storage


-
            IBM/OEM
      disk storage


-
            Hitachi
      Data Systems (HDS) products


-
            SAN
      and Storage maintenance including IBM, EMC and Hitachi Data System
      (HDS)


-
            Tape:
      IBM, Sun/STK 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 15 other states including Colorado, Illinois, Indiana, Kansas, Maine,
Michigan, Nebraska, New Jersey, New York, North Carolina, Ohio, Pennsylvania,
South Carolina, Texas and Wyoming.








Data
Center Hardware Segment:





We
support our Data Center Maintenance clients' IT hardware needs as well as the IT
needs of companies nationwide through our selling of refurbished
enterprise-class hardware and associated peripheral products.






3





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.  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. Subject to our ability to re-furbish or reconfigure a used
mainframe, 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 can be 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.





During
the third quarter, IBM significantly diminished our ability to resell zSeries
mainframe systems by setting onerous restrictions around the ability to upgrade
or downgrade the configuration deployed on a system.  As a result, we
discontinued the hardware trading portion of our hardware
business.  This caused goodwill and intangible impairment and the
Company had to totally write off the goodwill and intangibles related to this
segment.  The Company believes these restrictions to be actionable,
anti-competitive practices.  The Company will continue to support the
IT hardware needs of its maintenance customers.





Our Data Center Hardware group has its
technical facilities in Minnesota along with sales and marketing.





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.






4





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:





§
            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








5


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.





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





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.




6




We sell
and deliver our technology services to customers throughout the United States
and on 6 continents worldwide.  For the years ended December 31, 2007
and 2006, sales to our top ten customers comprised 31% and 44% of our revenue,
respectively.




A portion
of our revenues is also derived from export sales.  For the years
ended December 31, 2007 and 2006, export sales comprised 17% and 14% of revenue,
respectively.




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, 2008, we employed 83 full-time and 16 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-K, quarterly reports on Form 10-Q, 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 one of
several EPA certified recyclers.  For a fee, these recyclers manage
commodities and materials for recycling in accordance with applicable local,
state and federal laws, rules and regulations. Upon receipt of materials for
recycling, they 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.






7





Recent
      Developments




Other
Information






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.




On
January 17, 2007, the Company completed the financing of a new $7.5 million
working facility with Wells Fargo Bank, which increased and replaced a similar
based line of credit of $4.25 million.  The new revolving line of
credit agreement provides for borrowing 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.  On June
29, 2007, we completed an amendment to the revolving line-of-credit which reset
some of the covenants.




On
September 17, 2007, the Company held its annual stockholders meeting in Palm
Beach, Florida and re-elected Seth A. Grossman and R. Keith Elliott to the
Company's Board of Directors to hold office until the Company's Annual Meeting
of Stockholders in 2010 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,
2007.




On
February 6, 2008, Wells Fargo Bank notified the Company that although the
Company has performed its monetary obligations pursuant to its credit facility,
the Company did not meet certain operating metrics in its credit facility for
the fiscal year ended December 31, 2007.   While Wells Fargo Bank
has indicated to the Company that such an event constitutes a default under the
credit facility, it continues to work with the Company in a cooperative and
constructive manner in order to allow the Company to continue toward meeting the
operating metrics.  As a consequence, Wells Fargo Bank has charged the
Company a fee of $20,000 for maintaining the existing credit facility and
notified the Company that it will amend its borrowing rate to that of the prime
rate plus 2.5%.  Should the Company come back into compliance,
interest will be reduced to the prime rate.




Item
1A.                      Risk
Factors




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.






8




Fluctuations
      In Future Quarterly Results




We have
been in business since October 2001 and have only twenty five 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.




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 solely in the United States.  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, 2007 and 2006, our top ten customers accounted for approximately
31% and 44% of our total revenues, respectively. 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.




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.






9




For
the years ended December 31, 2007 and 2006, 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, 2007 and
2006, export sales comprised 17% and 14% of revenue,
respectively.  All of our purchases and sales are denominated in US
dollars.  We had a small call center in India, which we closed in
2007, where we recorded a small currency loss in our selling, general and
administrative expenses.




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.






10




If We Need Additional
Financing For Unanticipated Working Capital Needs Or To FinanceAcquisitions, 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.  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.




The
Company was unable to achieve these covenants in the fourth quarter, and is
considered to be in default of the line-of-credit.  As the Company is
in default, the lender has the right to terminate the agreement, causing all
amounts to become immediately due and payable.




As the
Company is in default under its line-of-credit agreement, it is pursuing certain
options, such as negotiating new terms with the financial institution or other
financial institutions.  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
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.  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.






11




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:




·
            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, Intechra and Tech Turn
      that offer asset management and end-of-life product refurbishment and
      remarketing services;




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






12




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:




Name
            PositionMarc
      Sherman
            Chairman,
      Chief Executive Officer, DirectorSeth
      A.
      Grossman
            President
      , Chief Operating Officer, DirectorEdward
      L.
      Cummings
            Chief
      Financial Officer, Treasurer, DirectorDavid
      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.




Item
1B.                      Unresolved
Staff Comments




None




Item
2.                                Properties




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 $178,000, 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.  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 $200.  These warehouses have
sufficient capacity for our current and estimated future business
needs.






13




This
segment also leases the following space:




1.
            In
      Portsmouth, New Hampshire approximately 1,600 square feet of office space
      pursuant to a one-year lease at a current annual rental of approximately
      $44,000.  This lease expires in October
  2008.




2.
            In
      Pleasantville, New York approximately 7,000 square feet of general
      warehouse and office space pursuant to a two-year lease at a current
      annual rental of approximately $70,000.  This facility, with
      approximately 5,000 feet of warehouse space, is in good
      condition.  This lease expires in October
  2009.




3.
            In
      Palm Beach, Florida approximately 2,662 square feet of office space
      pursuant to a five-year lease at a current annual rental of approximately
      $113,000.  This lease expires in March,
  2012.




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 has adequate capacity
for our current and estimated future business needs.  This lease
expires in October 2009.




Item
3.                                Legal
Proceedings


The
Company settled out of court a suit that had been initialed in the United States
District Court, Southern District of Florida, QSGI v. Anysystems, et.
al.  In this suit, the Company was seeking damages for losses incurred
as a result of the Company's dealings and interactions with the named
Defendants.




The
Company is also 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.




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, 2007.




PART II




Item
5.Market
for Registrant's Common Equity, Related Stockholder matters and Issuer Purchases
of Equity Securities




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.”






14





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, 2007
            High
            
            LowFirst
      Quarter
            
            $
      1.40
            
            $
      0.90Second
      Quarter
            
            0.99
            
            0.62Third
      Quarter
            
            0.88
            
            0.47Fourth
      Quarter
            
            0.59
            
            0.20Years
      Ended December 31, 2006First
      Quarter
            
            $2.10
            
            $
      1.55Second
      Quarter
            
            1.85
            
            1.27Third
      Quarter
            
            1.74
            
            1.26Fourth
      Quarter
            
            1.56
            
            0.95







Holders




As of
March 1, 2008, there were approximately 3,300 holders of record of the Company’s
Common Stock and the closing price was $0.34.  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
2007, the Company paid $258,000 in dividends on its redeemable convertible
preferred stock. The 6% dividend is payable quarterly in cash or additional
preferred securities, at the same price as originally issued, at the Company’s
option.  The company chose to pay all 2007 dividends in
cash.




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, 2007, 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
            7,569,834
            $1.807
            6,433,500Equity
      compensation plans not approved by security holders
            3,800,000
            $2.177
            -Total
            11,369,834
            $1.930
            6,433,500






15




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.




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-K.




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, or (6) the exercise of stock warrants.






16




Name/Entity/Nature
            Date Issued
            Note
            Number
      of Persons
            Issued For
            Number
      of Common
              SharesMichael
      Weiss
            May
      - 04
            1
            1
            Private
      Placement Shares
            83,400Odin
      Partners, LP
            May
      - 04
            1
            1
            Private
      Placement Shares
            116,600Barron
      Partners, LP
            May
      - 04
            1
            1
            Private
      Placement Shares
            4,833,333Guerilla
      Partners, LP
            May
      - 04
            1
            1
            Private
      Placement Shares
            716,600Guerilla
      IRA Partners, LP
            May
      - 04
            1
            1
            Private
      Placement Shares
            83,400Bismark
      Investment
            May
      - 04
            1
            1
            Private
      Placement Shares
            166,667Joel
      Owens
            May
      - 04
            2
            1
            Acquisition
            1,715,911Jolene
      Owens
            May
      - 04
            2
            1
            Acquisition
            241,920Robert
      Jackson
            Nov
      - 04
            3
            1
            Exercise
      of Stock Options
            200,000Carl
      Saracino
            Nov
      - 04
            3
            1
            Exercise
      of Stock Options
            150,000Michael
      Sheerr
            Nov
      - 04
            3
            1
            Exercise
      of Stock Options
            150,000Guerilla
      IRA Partners, LP
            Oct
      - 04
            4
            1
            Exercise
      of Stock Warrants
            41,700Guerilla
      Partners, LP
            Oct
      - 04
            4
            1
            Exercise
      of Stock Warrants
            358,300Odin
      Partners, LP
            Oct
      - 04
            4
            1
            Exercise
      of Stock Warrants
            58,300Michael
      Weiss
            Oct
      - 04
            4
            1
            Exercise
      of Stock Warrants
            41,700Andrew
      T. Trailor
            Jul
      - 04
            5
            1
            Shares
      Issued for Services
            35,140Duncan
      J Farmer
            Jul
      - 04
            5
            1
            Shares
      Issued for Services
            35,141Alan
      Burger
            Jul
      - 04
            5
            1
            Shares
      Issued for Services
            35,141Andrew
      T. Trailor
            Dec
      - 04
            5
            1
            Shares
      Issued for Services
            6,000Alan
      Burger and Dana Burger, Joint Tenants
            Dec
      - 04
            5
            2
            Shares
      Issued for Services
            6,000Duncan
      J Farmer
            Dec
      - 04
            5
            1
            Shares
      Issued for Services
            6,000Lois
      Rosenberg
            Jan
      - 05
            3
            1
            Exercise
      of Stock Options
            125,000Robert
      Jackson
            Jan
      - 05
            3
            1
            Exercise
      of Stock Options
            75,000David
      A. Loppert
            Jan
      - 05
            3
            1
            Exercise
      of Stock Options
            375,000Brian
      Cockerham
            Feb
      - 05
            3
            N
            Exercise
      of Stock Options
            10,000Eleanor
      Macdonald
            Feb
      - 05
            3
            1
            Exercise
      of Stock Options
            25,000Wayne
      Neuls
            Feb
      - 05
            3
            1
            Exercise
      of Stock Options
            25,000Louis
      Nuccio
            Feb
      - 05
            3
            1
            Exercise
      of Stock Options
            50,000Jack
      Tull
            Feb
      - 05
            3
            1
            Exercise
      of Stock Options
            10,000David
      A. Loppert
            Mar
      - 05
            3
            1
            Exercise
      of Stock Options
            1,100,000David
      Rubin
            Aug
      - 05
            3
            1
            Exercise
      of Stock Options
            6,666Dominick
      & Dominick
            Mar
      - 05
            4
            1
            Exercise
      of Stock Warrants
            400,000Paul
      Lee Newman
            Mar
      - 05
            4
            1
            Exercise
      of Stock Warrants
            100,000Bismark
      Intervest
            Apr
      - 05
            4
            1
            Exercise
      of Stock Warrants
            183,333Barron
      Partners
            Apr
      - 05
            4
            1
            Exercise
      of Stock Warrants
            550,000Alan
      Burger and Dana Burger,
              Joint
      Tenants
            Dec
      - 05
            5
            2
            Shares
      Issued for Services
            51,375Duncan
      J. Farmer
            Dec
      - 05
            5
            1
            Shares
      Issued for Services
            34,250Michael
      Sheerr
            Jan
      - 06
            3
            1
            Exercise
      of Stock Options
            100,000John
      W. Heilshorn
            Feb
      - 06
            5
            1
            Shares
      Issued for Services
            24,000Keith
      L. Lippert
            Feb
      - 06
            5
            1
            Shares
      Issued for Services
            24,000Whitmer
      & Worrall, LLC
            Mar
      - 06
            5
            1
            Shares
      Issued for Services
            40,540Michael
      Sheerr
            Mar
      - 06
            3
            1
            Exercise
      of Stock Options
            250,000Joel
      Owens
            Jun
      - 06
            6
            1
            Acquisition
            2,063,545







17




1.
            
            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.2.
            
            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.3.
            
            Represents
      shares issued in connection with the exercise of common stock
      options.4.
            
            Represents
      shares issued in connection with the exercise of common stock
      warrants.5.
            
            Represents
      shares issued for services rendered.6.
            
            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.




Item 6.
            Selected
      Financial Data




The
Company qualifies as a smaller reporting company and is not required to provide
the information required by this item.






Item 7.
            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.






18




Overview





We are a
technology services and maintenance company.  Our Data Center
Maintenance and Hardware services as well as our Data Security and Compliance
services are geared towards both the users of enterprise-class hardware
(mainframes, midrange processors, large storage, controllers, etc.) as well as
the users of business-computing hardware (desktops, laptops, related peripherals
and servers).  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.




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, 2007 and 2006.




Year
      Ended
            Year
      EndedDecember
      31, 2007
            December
      31, 2006%
            %Product
      Revenue
            80.9
            88.6Service
      Revenue
            19.1
            11.4Total
      Revenue
            100.0
            100.0Cost
      of Products Sold
            68.5
            74.9Cost
      of Services Sold
            6.8
            3.9Cost
      of sales
            75.3
            78.8Gross
      profit
            24.7
            21.2Selling,
      general and administrative expenses
            26.6
            20.8Goodwill
      and asset impairment
            19.4
            -Depreciation
      and amortization
            1.9
            1.5Interest
      expense
            1.1
            0.5Loss
      before provision (benefit) for income taxes
            (24.3)
            (1.6)Provision
      (benefit) for income taxes
            0.6
            (0.5)Net
      loss
            (24.9)
            (1.1)




Year
Ended December 31, 2007 Compared to Year Ended December 31, 2006




Revenue
for the year ended December 31, 2007 was $37,221,110 compared to revenue of
$46,408,917 for the year ended December 31, 2006, a $9,187,807 decrease, or
19.8%.  This sharp decline is due to what the Company believes to be
anti-competitive practices by a leading OEM.  These practices have
significantly impacted the entire industry for remarketing zSeries mainframe
systems and, since implemented during the third quarter, have had a substantial,
adverse financial impact on the Data Center Hardware segment and has caused the
Company to be in default of the financial covenants of its line-of-credit
agreement with Wells Fargo Bank and has caused impairment of goodwill and
intangibles associated with the Data Center Hardware
segment.  Discussions are ongoing with the OEM to address the
practices believed to be anticompetitive.  We also experienced a
decrease in revenues in our Data Security and Compliance segment as a result of
a decrease in our wholesale remarketing revenues caused by delays in corporate
IT rollouts.  These decreases were partially offset by a double digit
organic growth within the Data Center Maintenance segment and double digit
organic growth within the services revenue within the Data Security and
Compliance segment.






19




Our
revenues categorized by products and services are as follows:


Year
      Ended
            
            
            Year
      EndedDecember
      31, 2007
            
            
            December
      31, 2006RevenueProducts
            
            $
            30,126,257
            
            
            $
            41,111,420Services
            
            
            7,094,853
            
            
            
            5,297,497Total
      Revenue
            
            $
            37,221,110
            
            
            $
            46,408,917




Our
revenue by geographic segment is as follows:




Years
      Ended December 31,
            2007
            %
            2006
            %
            Change
            %
      ChangeUnited
      States
            
            $31,028,368
            83%
            $40,024,087
            86%
            $(8,995,719)
            (22)%Asia
            
            1,394,935
            4%
            1,824,038
            4%
            (429,103)
            (24)%Europe
            
            478,557
            1%
            219,608
            1%
            258,949
            118%Africa
            
            593,044
            2%
            602,447
            1%
            (9,403)
            (2)%United
      Kingdom
            
            485,478
            1%
            935,473
            2%
            (449,995)
            (48)%Canada
            
            556,392
            2%
            324,056
            1%
            232,336
            72%Middle
      East
            
            2,404,862
            6%
            1,823,709
            4%
            581,153
            32%Australia
            
            --
            --
            12,825
            --
            (12,825)
            (100)%South
      America
            
            279,474
            1%
            642,674
            1%
            (363,200)
            (57)%Total
            
            $37,221,110
            100%
            $46,408,917
            100%
            $(9,187,807)
            (20)%







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, 2007 and 2006, export
sales comprised approximately 17% and 14% of revenue,
respectively.  All of our purchases and sales are denominated in US
dollars.  We had a small call center in India which we closed in 2007
where we recorded a small currency loss in our selling, general and
administrative expenses.




Gross
profit for the year ended December 31, 2007 was $9,178,441 compared to a gross
profit of $9,860,403 for the year ended December 31, 2006, a $681,962 decrease,
or 6.9%.  Gross margin was 24.7% for the year ended December 31, 2007
compared to 21.2% for the year ended December 31, 2006.  Gross margins
increased due to a 31% organic growth in services gross profit.  This
growth along with a decline in product gross profit caused service gross profit
to be a higher percentage of total gross profit thereby increasing our
margins.




The
overall management of computer equipment throughout 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.






20




Selling,
general and administrative expenses for the year ended December 31, 2007, were
$9,905,064 compared to selling, general and administrative expenses of
$9,663,812 for the year ended December 31, 2006, a $241,252 increase, or
2.5%.  Selling, general and administrative expense increased due to an
increase in professional fees, and an increase in our India sales office
expenses, which was closed as we moved this operation back to the United
States.




Depreciation
and amortization for the year ended December 31, 2007, was $702,310 compared to
depreciation and amortization of $685,216 for the year ended December 31, 2006,
a $17,094 increase, or 2.5%.  This increase was the result of
amortization of intangibles as the result of assets acquired in a small asset
purchase.




Interest
expense for the year ended December 31, 2007, was $396,417 compared to interest
expense of $238,985 for the year ended December 31, 2006, a $157,432 increase,
or 65.9%, commensurate with an increase in the Company’s borrowings and an
increase in interest rates during 2007.




The
Company recorded a federal tax expense for the year ended December 31, 2007 and
a tax benefit for the year ended December 31, 2006.  At December 31,
2007, the Company did not recognize a deferred tax benefit as it increased its
deferred tax asset valuation allowance to be 100% of the Company's deferred tax
assets.  The tax amount is adjusted by estimated state tax obligations
in jurisdictions where the Company cannot file a consolidated income tax
return.





Segments





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





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.





Data
Center Hardware





We are a
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
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






21




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.




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.





2007
            
            
            2006RevenuesData Security And
      Compliance
            
            $
            20,741,618
            
            
            $
            22,013,739Data Center
      Hardware
            
            
            11,100,092
            
            
            
            20,035,133Data Center
      Maintenance
            
            
            6,264,981
            
            
            
            4,847,885Intersegment
      Elimination
            
            
            (885,581
            )
            
            
            (487,840
            )Consolidated
    Total
            
            $
            37,221,110
            
            
            $
            46,408,917








Data
Center Maintenance Segment





Year
      Ended
            
            
            Year
      EndedDecember
      31, 2007
            
            
            December
      31, 2006Revenue
            
            $
            6,264,981
            
            
            $
            4,847,885Gross
      Profit
            
            
            4,021,823
            
            
            
            3,260,003Selling,
      General and Administration
            
            
            2,739,891
            
            
            
            1,937,004Depreciation
      and Amortization
            
            
            59,308
            
            
            
            62,342Income
      Before Provisionfor
      Income Taxes
            
            
            1,222,624
            
            
            
            1,259,910Segment
      Assets
            
            
            3,559,629
            
            
            
            2,629,689Goodwill
            
            
            1,489,621
            
            
            
            1,489,621Expenditures
      for Property andEquipment
            
            
            -
            
            
            
            10,007







Revenue
for the year ended December 31, 2007 was $6,264,981 compared to revenue of
$4,847,885 for the year ended December 31, 2006, a $1,417,096 increase, or
29.2%.  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, 2007 was $4,021,823 compared to gross
profit of $3,260,003 for the year ended December 31, 2006, a $761,820 increase,
or 23.4%.  Gross margin in our Data Center Maintenance segment for the
year ended December 31, 2007 was 64.2% of revenue compared to 67.2% of revenue
for the year ended December 31, 2006.  Gross profit increased as a
result of the increase in revenues.






22




Selling,
general and administrative expenses for the year ended December 31, 2007 were
$2,739,891 compared to selling, general and administrative expenses of
$1,937,004 for the year ended December 31, 2006, a $802,887 increase or
41.4%.  This increase was mainly the result of compensation and
benefits as we increased personnel to support the growth in
revenues.




Depreciation
and amortization for the year ended December 31, 2007 was $59,308 compared to
depreciation and amortization of $62,342 for the year ended December 31, 2006, a
$3,034 decrease, or 4.9%.  This was the result of some of our assets
becoming fully depreciated during 2007.





Data
Center Hardware Segment





Year
      Ended
            
            
            Year
      EndedDecember
      31, 2007
            
            
            December
      31, 2006Revenue
            
            $
            11,100,092
            
            
            $
            20,035,133Gross
      Profit
            
            
            2,341,091
            
            
            
            3,752,742Selling,
      General and Administration
            
            
            1,999,516
            
            
            
            2,580,299Depreciation
      and Amortization
            
            
            343,347
            
            
            
            397,358Income
      (Loss) Before Provision(Benefit)
      for Income Taxes
            
            
            (7,208,456
            )
            
            
            775,849Segment
      Assets
            
            
            1,264,945
            
            
            
            12,669,721Goodwill
            
            
            -
            
            
            
            5,154,782Expenditures
      for Property andEquipment
            
            
            21,631
            
            
            
            16,564







Revenue
for the year ended December 31, 2007 was $11,100,092 compared to revenue of
$20,035,133 for the year ended December 31, 2006, an $8,935,041 decrease, or
44.6%.  This sharp decline is due to what the Company believes to be
actionable, anti-competitive practices by a leading OEM.  These
practices have significantly impacted the entire industry for remarketing
zSeries mainframe systems and, since implemented during the third quarter, have
had a substantial, adverse financial impact on the Data Center Hardware
segment.  This OEM significantly diminished our ability to resell
zSeries mainframe systems by setting onerous restrictions around the ability to
upgrade or downgrade the configuration deployed on the system.  As a
result, the Company is in default of the financial covenants of its
line-of-credit agreement with Wells Fargo Bank and has caused total impairment
of goodwill and intangibles associated with the Data Center Hardware
segment.






Gross
profit for the year ended December 31, 2007 was $2,341,091 compared to gross
profit of $3,752,742 for the year ended December 31, 2006, a $1,411,651
decrease, or 37.6%.  Gross margin in our Data Center Hardware segment
for the year ended December 31, 2007 was 21.1% of revenue compared to 18.7% of
revenue for the year ended December 31, 2006.  Although margins
increased on lower revenues, gross profit decreased due to lower
revenues.






Selling,
general and administrative expenses for the year ended December 31, 2007 were
$1,999,516 compared to selling, general and administrative expenses of
$2,580,299 for the year ended December 31, 2006, a $580,783 decrease, or
22.5%.  The decrease was the result of a strict cost containment
policy instituted at the beginning of 2006 coupled with personnel reductions as
we discontinued the trading of hardware equipment.






23




Depreciation
and amortization for the year ended December 31, 2007 was $343,347 compared to
depreciation and amortization of $397,358 for the year ended December 31, 2006,
a $54,011 decrease, or 13.6%.  This was the result of the sale of a
portion of our assets coupled with many assets becoming fully depreciated during
2007.








Data
Security & Compliance Segment








Year
      Ended
            
            
            Year
      EndedDecember
      31, 2007
            
            
            December
      31, 2006Revenue
            
            $
            20,741,618
            
            
            $
            22,013,739Gross
      Profit
            
            
            2,815,527
            
            
            
            2,847,658Selling,
      General and Administration
            
            
            5,165,657
            
            
            
            5,146,509Depreciation
      and Amortization
            
            
            299,655
            
            
            
            225,516Loss
      Before Benefitfor
      Income Taxes
            
            
            (3,046,216
            )
            
            
            (2,763,369
            )Segment
      Assets
            
            
            8,592,896
            
            
            
            8,879,411Goodwill
            
            
            -
            
            
            
            -Expenditures
      for Property andEquipment
            
            
            190,082
            
            
            
            127,087













Revenue
for the year ended December 31, 2007 was $20,741,618 compared to revenue of
$22,013,739 for the year ended December 31, 2006, a $1,272,121 decrease or
5.8%.  Revenues decreased as a result of a decrease in our wholesale
remarketing revenue due to a decrease in the flow of wholesale remarketing
product.  This was caused by a decrease in the number of IT
rollouts.  Offsetting this decrease was an increase in the number of
new and existing corporate customers utilizing our full suite of services which
helped our service revenue more than double to approximately
$1,000,000.




Gross
profit for the year ended December 31, 2007 was $2,815,527 compared to gross
profit of $2,847,658 for the year ended December 31, 2006, a $32,131 decrease or
1.1%.  Gross margin for the year ended December 31, 2007 was 13.6%
compared to 12.9% for the year ended December 31, 2006.  The
improvement in gross margin reflects the increase in the number of corporate
customers utilizing our full suite of higher margin data security
services.




Selling,
general and administrative expense for the year ended December 31, 2007 was
$5,165,657 compared to selling, general and administrative expense of $5,146,509
for the year ended December 31, 2006, a $19,148 increase.  This small
increase in selling, general and administrative expense shows the relative fixed
cost nature of our expenses even though individual expense categories may differ
from year to year.  During 2007, we saw an increase in professional
fees and insurance expense which was offset by a decrease in bad debt
expense.




Depreciation
for the year ended December 31, 2007 was $299,655 compared to depreciation of
$225,516 for the year ended December 31, 2006, a $74,139 increase or
32.9%.  This was mainly due to amortization of intangibles as the
result of assets acquired in a small asset purchase plus one full year of
depreciation for fixed asset acquisitions that occurred during 2006 and a
portion of the year for 2007.








24




Liquidity
and Capital Resources




Our
current ratios at December 31, 2007 and December 31, 2006 were 1.7 to 1 and 2.1
to 1, respectively.  Working capital at December 31, 2007 was
$4,363,914 compared to $7,539,917 at December 31, 2006.  Working
capital at December 31, 2007 decreased due to financing the operations of the
company and a decrease in accounts receivable.  This was offset by an
increase in inventory.




Net cash
provided by operating activities for the year ended December 31, 2007 was
$234,828 compared to $1,583,230 of cash used in operating activities for the
year ended December 31, 2006.  Cash provided by operating activities
for the year ended December 31, 2007 was primarily a result of a decrease in
accounts receivable, mainly attributable to the decrease in revenues in our Data
Center Hardware segment.  This was offset by an increase in inventory,
a decrease in accounts payable, accrued expenses and other liabilities and the
net loss.  Inventory increased due to new product purchases and an
increase in parts needed to support our maintenance contracts.  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.




Net cash
used in investing activities for the years ended December 31, 2007 and 2006 was
$192,462 and $145,454, respectively.  For the year ended December 31,
2007, cash was used for the purchase of property and equipment and advances for
notes receivable, offset by the proceeds from the sale of property and equipment
and the collections on notes receivable.  For the year ended December
31, 2006, cash was used for the purchase of property and equipment.




Net cash
used in financing activities for the year ended December 31, 2007 was
$547,591.  Net cash provided by financing activities for the years
ended December 31, 2006 was $2,207,838.  For the year ended December
31, 2007, net cash was used to pay for loan financing costs, preferred stock
dividends and to reduce the revolving line of credit.  For the year
ended December 31, 2006, net cash was provided by proceeds from the issuance of
redeemable convertible preferred stock, and net amounts borrowed under revolving
lines of credit, reduced by preferred stock dividends.




On
January 17, 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.  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.  All
principal and any outstanding interest is due January 24, 2010.  In
accordance with 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 paid and cancelled.




On June
29, 2007, we completed an amendment to the revolving line-of-credit which reset
some of the covenants.  Interest on the loan is payable monthly at the
prime rate plus one and one-half percent (8.75% at December 31, 2007), with all
principal and interest due January 24, 2010.  Prior to June 29, 2007,
interest on this loan was payable monthly at the prime rate.  Interest
on our previous loan was payable monthly at the prime rate plus one
percent.






25




The
amended revolving line-of-credit agreement contains certain financial covenants,
including minimum net income requirements as follows:




Year
      To DateNet
      IncomePeriod
      Ending
            
            (Loss)March
      31, 2007
            
            $
            (250,000
            )June
      30, 2007
            
            
            (428,000
            )September
      30, 2007
            
            
            (337,000
            )December
      31, 2007
            
            
            (49,000
            )March
      31, 2008
            
            
            100,000June
      30, 2008
            
            
            300,000September
      30, 2008
            
            
            500,000December
      31, 2008
            
            
            800,000March
      31, 2009
            
            
            100,000June
      30, 2009
            
            
            300,000September
      30, 2009
            
            
            500,000December
      31, 2009
            
            
            800,000







The
Company was unable to achieve these covenants in the fourth quarter, and is
considered to be in default of the line-of-credit.  As the Company is
in default, the lender has the right to terminate the agreement, causing all
amounts to become immediately due and payable.




As the
Company is in default under its line-of-credit agreement, it is pursuing certain
options, such as negotiating new terms with the financial institution or other
financial institutions.  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 in 2008 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.




On
February 6, 2008, Wells Fargo Bank notified the Company that although the
Company has performed its monetary obligations pursuant to its credit facility,
the Company did not meet certain operating metrics in its credit facility for
the fiscal year ended December 31, 2007.   While Wells Fargo Bank
has indicated to the Company that such an event constitutes a default under the
credit facility, it continues to work with the Company in a cooperative and
constructive manner in order to allow the Company to continue toward meeting the
operating metrics.  As a consequence, Wells Fargo Bank has charged the
Company a fee of $20,000 for maintaining the existing credit facility and
notified the Company that it will amend its borrowing rate to that of the prime
rate plus 2.5%.  Should the Company come back into compliance,
interest will be reduced to the prime rate.




We do not
have any material commitments for capital expenditures nor do we expect to incur
any material commitments for capital expenses during 2008.




We did
not have any significant elements of income or loss not arising from continuing
operations in 2007 or 2006 and do not expect any in 2008.  While our
business is marginally seasonal, we do not expect this seasonality to have a
material adverse effect on our results of operations or cash flows.






26




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.




Item
7A.                      Quantitative
and Qualitative Disclosures About Market Risk




The
Company qualifies as a smaller reporting company and is not required to provide
the information required by this item.




Item
8.Financial
Statements AND Supplementary Data




Our financial statements included in
this Annual Report on Form 10-K are listed in Item 13 and begin immediately
after Item 14 on pages F-1 through F-32.




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 8.




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 4% 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, 2007 and
2006.  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.






27




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 collectability 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 a result of the impairment test performed at December 31,
2007, the Company determined that the carrying value of goodwill and intangibles
was impaired and recorded an impairment charge of $7,206,698.  Of this
amount $5,154,782 was for goodwill impairment and $2,051,916 was for intangible
impairment.  These impairment charges were all associated with the
Data Center Hardware reporting unit.  This impairment was caused by
what the Company believes to be anti-competitive practices by a leading
OEM.  These practices have significantly impacted the entire industry
for remarketing zSeries mainframe systems and, since implemented during the
third quarter, have had a substantial, adverse financial impact on the Data
Center Hardware segment.  As of December 31, 2006 the Company
performed impairment tests and determined that the carrying value of such assets
were not impaired as of that date.




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.






28







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 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 was effective for the Company
beginning January 1, 2007.




As a
result of the implementation of FIN 48, the Company recognized an increase of
$38,000 in the liability for income taxes and accrued interest, of which $3,000
related to accrued interest.  This was accounted for as a reduction to
the January 1, 2007 balance of retained earnings.  Including the
cumulative effect increase on January 1, 2007, the Company had $368,000 of
unrecognized tax benefits of which $35,000 would affect the effective tax rate
if recognized.  Following implementation, the ongoing recognition of
changes in measurement of uncertain tax positions as well as interest and
penalties related to unrecognized tax benefits will be reflected as a component
of income tax expense.






Item 9.
            Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure




None




Item 9A (T).
            Controls
      and procedures




Evaluation of Disclosure Controls and
Procedures




We
maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed by us in the reports we file or submit
under the Securities Exchange Act of 1934, as amended, is recorded, processed,
summarized and reported within the time periods required by the Securities and
Exchange Commission, including, without limitation, those controls and
procedures designed to ensure that such information is accumulated and
communicated to our management to allow timely decisions regarding required
disclosures.






29




Under the
supervision and with the participation of our management, including our Chief
Executive Officer and Chief Financial Officer, we have conducted an evaluation
of the effectiveness of the design and operation 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, 2007.  Based upon this evaluation our
management, including our Chief Executive Officer and Chief Financial Officer,
has concluded that our disclosure controls and procedures as of the end of the
period covered by this report were not effective, due to the material weaknesses
in internal control over financial reporting described below, at the reasonable
assurance level such that the information required to be disclosed by us in
reports filed under the Exchange Act is (i) recorded, processed, summarized
and reported within the time periods specified in the rules and forms of the
Securities and Exchange Commission and (ii) accumulated and communicated to
our management, including our Chief Executive Officer and Chief Financial
Officer, as appropriate to allow timely decisions regarding disclosure. In
designing and evaluating the disclosure controls and procedures, management
recognized that any controls system cannot provide absolute assurance, however,
that the objectives of the controls system are met, and no evaluation of
controls can provide absolute assurance that all control issues and instances of
fraud, if any, within a company have been detected.




Management's
Report on Internal Control Over Financial Reporting




Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting (as defined in Rule 13a-15(f) under the
Exchange Act).  Our internal control over financial reporting is a
process designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external
purposes in accordance with accounting principles generally accepted in the
United States.




However,
because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements.  Therefore, even those
systems determined to be effective can provide only reasonable assurance with
respect to financial statement preparation and presentation.  Also,
projections of any evaluation of effectiveness to future periods are subject to
the risk that internal controls may become inadequate because of changes in
conditions, or the degree of compliance with policies may vary.




Our
management, with the participation of the Chief Executive Officer and Chief
Financial Officer, evaluated the effectiveness of the Company's internal control
over financial reporting as of December 31, 2007.  In making this
assessment, our management used the criteria set forth by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO) in Internal
Control—Integrated Framework.  Based on this evaluation, our
management, with the participation of the Chief Executive Officer and Chief
Financial Officer, concluded that, as of December 31, 2007, our internal
control over financial reporting was not effective based on those
criteria.




Our Board
of Directors were advised by RubinBrown LLP., our independent registered public
accounting firm, that during their performance of the audit for the year ended
December 31, 2007, they identified two material weaknesses in our internal
control over financial reporting.  They are as follows:






30




1.
            A
      material weakness in the Company's internal controls exists in that there
      is not an effective control to ensure the accuracy and completeness in the
      determination of the allowance for doubtful
  accounts.




Management
is required to apply judgment in evaluating that the allowance for doubtful
accounts is adequate.  To remedy the situation, the Chief Financial
Officer, President and Chief Executive Officer will sign off on the recommended
allowance for doubtful accounts.




2.
            A
      material weakness in the Company's internal controls exists in that there
      is not an effective control related to: (i) the application of appropriate
      assumptions related to goodwill and intangible impairment analysis; and
      (ii) the monitoring of the recording of appropriate reserves for income
      taxes.




Although
the Company uses an outside firm to calculate the goodwill and intangible
impairment and outside firm to calculate the appropriate amount of income taxes
for the year, the Company will monitor the calculations more closely in the
future.




No
Attestation of Registered Public Accounting Firm




This
annual report does not include an attestation report of the Company's registered
public accounting firm regarding internal control over financial reporting.
Management's report was not subject to attestation by the Company's registered
public accounting firm pursuant to temporary rules of the Securities and
Exchange Commission that permit the Company to provide only management's report
in this annual report.




Item 9B.
            Other
      Information




None




Part
III




Item 10.
            Directors,
      Executive Officers, and Corporate
Governance




AS
of March 1, 2008, Our Directors and Executive Officers are:




Name
            Age
            PositionMarc
      Sherman
            44
            Chairman,
      Chief Executive Officer, DirectorSeth
      A.
      Grossman
            42
            President,
      Chief Operating Officer, DirectorEdward
      L. Cummings
            59
            Chief
      Financial Officer, Treasurer, DirectorDavid
      Harris
            45
            Vice
      President, Information Technology and SystemsR.
      Keith
      Elliott
            66
            DirectorRobert
      W. VanHellemont
            62
            DirectorGeoffrey
      A. Smith
            50
            DirectorJohn
      F. Cunningham
            64
            Director







31






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 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.




Seth A. Grossmanwas hired on
March 14, 2005 as the President and Chief Operating Officer.He hadjoined the Board of
Directors in November 2003.  His term of office expires at the 2010
annual meeting.  Prior to joining the Company, 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. Harrisjoined 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 2010 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.






32




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.




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;






33






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




·
            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
11.                      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.







34




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.




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.






35




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.






36




Perquisites




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




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 the two other most highly
compensated officers that was paid by us during the fiscal years ended December
31, 2007 and 2006.




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)
            2007
            $
      424,000
            -
            -
            -
            -
            -
            
            $
      20,000
            
            $   444,000Chairman,
      CEO and
            2006
            $
      424,000
            $   67,690
            -
            -
            -
            -
            
            $
      20,000
            
            $   511,690PresidentSeth
      A. Grossman(1)
            2007
            $
      339,200
            -
            -
            -
            -
            -
            
            $          -
            
            $   339,200President
      and Chief
            2006
            $
      339,200
            $   51,455
            -
            -
            -
            -
            
            $          -
            
            $   390,655Operating
      OfficerEdward
      L. Cummings(1)
            2007
            $
      254,400
            -
            -
            -
            -
            -
            
            $          -
            
            $   254,400CFO
      and Treasurer
            2006
            $
      254,400
            $   24,270
            -
            -
            -
            -
            
            $          -
            
            $   278,677Joel
      L. Owens(2)
            2007
            $
      463,457
            -
            -
            -
            -
            -
            
            $         -
            
            $   463,457Vice
      President
            2006
            $
      463,877
            -
            -
            -
            -
            -
            
            $         -
            
            $   463,877Vivek
      J. Agarwal(3)
            2007
            $
      158,057
            -
            -
            4,828
            -
            -
            
            $         -
            
            $   162,885Sales
      Representative
            2006
            $
      200,000
            -
            -
            -
            -
            -
            
            $         -
            
            $   200,000


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




(2)
            Employment
      ended on November 15, 2007.




(3)
            Two
      grants were issued.  The option value was based on the grant
      date fair value of $1.01 and $1.80 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
      88.36%; risk-free interest rate of 4.15%; and expected lives of 1.6
      years.






37




Grants
      of Plan-Based Awards




The
following table contains information concerning the grant of Stock Options to
the named executive officers during 2007:




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
            -
            
            -
            -
            -
            
            -
            -
            -
            
            -
            
            -
            -






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, 2007:




Outstanding
      Equity Awards at Fiscal Year-EndOption
      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
            
            --
            
            --




(1)
            All
      options have vested.








38


Options
Exercises and Stock Vested




Outstanding
      Equity Awards at Fiscal Year-EndOption
      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
            
            --
            --
            
            --
            
            --




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.




Director CompensationName of
      Director
            Fees Earned
      or 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






39




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
      CompensationMarc
      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
            $        254,400







(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.




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.




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.






40




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, 2007:




Post
      Employment CompensationName
            
            2008
      ($)
            2009
      ($)
            2010
      ($)Marc
      Sherman
            
            424,000
            424,000
            424,000Seth
      A. Grossman
            
            339,200
            339,200
            339,200Edward
      L. Cummings
            
            254,400
            254,400
            254,400




Item 12.
            Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters




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, 2007:




Title of Class
            Name and Address of Beneficial
      Owner
            Amount
      and Nature of
              Beneficial Owner(1)
            Percent of ClassCommon
            Marc
      Sherman (2)
              c/o
      70 Lake Drive
              Hightstown,
      NJ 08520
            6,025,000
            14.2%Common
            Seth
      A. Grossman
              c/o
      70 Lake Drive
              Hightstown,
      NJ 08520
            3,425,000
            8.1%Common
            Edward
      L. Cummings
              c/o
      70 Lake Drive
              Hightstown,
      NJ 08520
            3,718,200
            8.7%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
            *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 (7 Persons)
            14,346,000
            33.7%







41







*       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; 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 (7 persons) – 9,400,000.


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 1, 2008, 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 ClassProfessional
      Offshore Opportunity Fund, LTD
              1400
      Old Country Road
              Westbury,
      NY  11590
            
            2,930,478
            
            9.4%Pike
      Capital Partners, LP
              275
      Madison Avenue
              Suite
      418
              New
      York, NY  10016
            
            5,555,982
            
            17.8%






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
13                      Certain
Relationships and Related Transactions, and Director Independence




Loans
from Principal Stockholders/Executive Officers




As of
December 31, 2007 and 2006, 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 $85,000 and $158,000 for the years ended
December 31, 2007 and 2006, respectively.  Accounts receivable from
this customer amounted to $49,529 at December 31, 2007.  No accounts
receivable from this customer was outstanding at December 31, 2006.






42




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, 2007 and 2006, rent expense
for this lease amounted to $221,788 and $179,585, respectively.  No
accounts payable were due to this vendor at December 31, 2007 and
2006.




In
November 2007, the Company exercised an option to purchase a portion of the
assets from Varilease Technology Finance Group for approximately
$35,000.  This purchase reduces the monthly rental by approximately
$10,600 per month.  No accounts payable was outstanding to this vendor
at December 31, 2007 and 2006.




Shares
issued to Principal Stockholders/Executive Officers




Principal Stockholder / Executive
      Officer
            Date Issued
            Note
            Issued For
            Number
      of Common
              SharesEdward
      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






43




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.




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.




Item
14.                      Principal
accountant fees and services




During 2007 and 2006, we paid the
following fees, including out of pocket expense reimbursements, to RubinBrown
LLP:




2007
            2006Audit
      Fees
              Audit-Related
      Fees (1)
              Tax
      Fees (2)
              Total
            $200,000
              62,000
              48,000
              $310,000
            $
      147,109
              43,123
              22,950
              $
      213,182




(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.




(2)  Tax
      Fees include tax planning, compliance for federal and state income taxes,
      and assistance with IRS
examinations.




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.









44




PART
IV




Item
15.                      Exhibits
and Financial Statements




ExhibitsSee
      List of Exhibits filed as part of this Report on Form
  10-K.The
      financial statements listed below appear immediately after page
      47.Report
      of Independent Registered Public Accounting Firm
            F-1 – F-2Financial
      StatementsBalance
      Sheet
            F-3 – F-4Statement
      Of Operations
            F-5Statement
      Of Stockholders’ Equity
            F-6Statement
      Of Cash Flows
            F-7Notes
      To Financial Statements
            F-8 – F-32






45




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:                      April
      14, 2008
            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
            April
      14, 2008/s/
      Seth A. Grossman
              Seth
      A. Grossman
            President,
      Chief Operating Officer and Director
            April
      14, 2008/s/
      Edward L. Cummings
              Edward
      L. Cummings
            Chief
      Financial Officer, Treasurer and Director
            April
      14, 2008/s/
      R. Keith Elliott
              R.
      Keith Elliott
            Director
            April
      14, 2008/s/
      Robert W.  VanHellemont
              Robert
      W. VanHellemont
            Director
            April
      14, 2008/s/
      Geoffrey A. Smith
              Geoffrey
      A. Smith
            Director
            April
      14, 2008/s/
      John F. Cunningham
              John
      F. Cunningham
            Director
            April
      14, 2008








46




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)).








47




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-K.







48





QSGI INC. AND SUBSIDIARIES
 CONSOLIDATED
FINANCIALSTATEMENTS
 DECEMBER
31, 2007
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  
 Contents
 PageReport
      Of Independent Registered PublicAccounting
      Firm
                F-1 - F-2Financial
      StatementsConsolidated
      Balance Sheets
                F-3 - F-4Consolidated
      Statements Of Operations
                F-5Consolidated
      Statements Of Stockholders’ Equity
                F-6Consolidated
      Statements Of Cash Flows
                F-7Notes
      To Consolidated Financial Statements
                F-8 - F-33
  
 
 
 Report Of Independent Registered Public Accounting
Firm
 
 
 Board of
Directors and Stockholders
 QSGI
INC.
 Hightstown,
New Jersey
 
 
 We have
audited the accompanying consolidated balance sheets of QSGI INC. and
subsidiaries as of December 31, 2007 and 2006, and the related consolidated
statements of operations, stockholders’ equity and cash flows for the years then
ended.  These consolidated financial statements are the responsibility
of the Company’s management.  Our responsibility is to express an
opinion on these consolidated 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 consolidated financial statements are free of material
misstatement.  The Company is not required to have, nor were we
engaged to perform, an audit of its internal control over financial
reporting.  Our audit included consideration of internal control over
financing 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 consolidated financial statements, assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall consolidated financial statement
presentation.  We believe that our audits provide a reasonable basis
for our opinion.
 
 We were
not engaged to examine management’s assertion about the effectiveness of the
Company’s internal control over financial reporting as of December 31, 2007,
included in the accompanying Management’s Report on Internal Control over
Financial Reporting and, accordingly, we do not express an opinion
thereon.
   
 Board Of
Directors And Stockholders
 QSGI,
INC.
  In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the consolidated financial position of QSGI INC. and
subsidiaries as of December 31, 2007 and 2006, 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.
 
 The
accompanying consolidated financial statements have been prepared assuming that
the Company will continue as a going concern.  As discussed in Note 1
to the consolidated financial statements, the Company has reported significant
losses from operations and is in default of its line-of-credit
agreement.  These conditions raise substantial doubt about its ability
to continue as a going concern.  Management’s plans regarding those
matters also are described in Note 1.  The consolidated financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
  /s/ RubinBrown
LLP
  St.
Louis, Missouri
 April 14,
2008
 
   Page
F-2
  QSGI
INC. AND SUBSIDIARIES
 CONSOLIDATED
BALANCESHEETS
 Page
1 Of 2
 AssetsDecember
      31,2007
                
                
                2006Current
      AssetsCash
      and cash equivalents
                
                $
                127,723
                
                
                $
                632,948Accounts
      receivable, net of reserve of $955,599and $780,116 in 2007 and 2006, respectively
                
                
                3,853,362
                
                
                
                8,012,421Inventories
                
                
                6,578,031
                
                
                
                4,982,710Prepaid
      expenses and other assets
                
                
                163,553
                
                
                
                183,069Deferred
      income taxes
                
                
                —
                
                
                
                598,661Total
      Current Assets
                
                
                10,722,669
                
                
                
                14,409,809Property
      And Equipment, Net
                
                
                286,766
                
                
                
                410,241Goodwill
                
                
                1,489,621
                
                
                
                6,644,403Intangibles,
      Net
                
                
                470,348
                
                
                
                2,555,584Other
      Assets
                
                
                448,066
                
                
                
                158,784$
                13,417,470
                
                
                $
                24,178,821
 
 See
the accompanying report letter and notes to consolidated financial
statements.
 Page
F-3
  QSGI
INC. AND SUBSIDIARIES
 CONSOLIDATED
BALANCE SHEETS
 Page
2 Of 2
  Liabilities
      And Stockholders' EquityDecember
      31,2007
                
                
                2006Current
      LiabilitiesRevolving
      line of credit
                
                $
                3,754,061
                
                
                $
                3,915,825Accounts
      payable
                
                
                1,109,940
                
                
                
                1,382,336Accrued
      expenses
                
                
                654,461
                
                
                
                601,850Accrued
      payroll
                
                
                88,818
                
                
                
                329,658Deferred
      revenue
                
                
                439,865
                
                
                
                517,439Other
      current liabilities
                
                
                311,610
                
                
                
                122,784Total
      Current Liabilities
                
                
                6,358,755
                
                
                
                6,869,892Long-Term
      Deferred Revenue
                
                
                142,772
                
                
                
                416,239Deferred
      Income Taxes
                
                
                27,300
                
                
                
                451,625Total
      Liabilities
                
                
                6,528,827
                
                
                
                7,737,756Redeemable
      Convertible Preferred Stock
                
                
                4,238,685
                
                
                
                4,220,577Commitments
      And Contingencies (Notes 1, 6 And 13)Stockholders'
      EquityCommon
      shares: authorized 95,000,000 in 2007 and 2006,$0.01 par value; 31,172,716 shares issued and outstandingin 2007 and 2006
                
                
                311,727
                
                
                
                311,727Additional
      paid-in capital
                
                
                14,134,298
                
                
                
                14,390,976Retained
      earnings (deficit)
                
                
                (11,796,067
                )
                
                
                (2,482,215
                )Total
      Stockholders' Equity
                
                
                2,649,958
                
                
                
                12,220,488$
                13,417,470
                
                
                $
                24,178,821
   See
the accompanying report letter and notes to consolidated financial
statements.
 Page
F-4
  QSGI
INC. AND SUBSIDIARIES
 
 For
      The YearsEndedDecember 31,2007
                
                
                2006Product
      Revenue
                
                $
                30,126,257
                
                
                $
                41,111,420Service
      Revenue
                
                
                7,094,853
                
                
                
                5,297,497Total
      Revenue
                
                
                37,221,110
                
                
                
                46,408,917Cost
      Of Products Sold
                
                
                25,525,836
                
                
                
                34,742,022Cost
      Of Services Sold
                
                
                2,516,833
                
                
                
                1,806,492Cost
      Of Sales
                
                
                28,042,669
                
                
                
                36,548,514Gross
      Profit
                
                
                9,178,441
                
                
                
                9,860,403Selling,
      General And Administrative Expenses
                
                
                9,905,064
                
                
                
                9,663,812Goodwill
      And Asset Impairment
                
                
                7,206,698
                
                
                
                —Depreciation
      And Amortization
                
                
                702,310
                
                
                
                685,216Interest
      Expense, Net
                
                
                396,417
                
                
                
                238,985Loss
      Before Provision (Benefit) For Income Taxes
                
                
                (9,032,048
                )
                
                
                (727,610
                )Provision
      (Benefit) For Income Taxes
                
                
                243,804
                
                
                
                (242,373
                )Net
      Loss
                
                
                (9,275,852
                )
                
                
                (485,237
                )Accretion
      To Redemption Value Of Preferred Stock
                
                
                18,108
                
                
                
                17,056Preferred
      Stock Dividend
                
                
                258,000
                
                
                
                256,389Net
      Loss Available To Common Stockholders
                
                $
                (9,551,960
                )
                
                $
                (758,682
                )Net
      Loss Per Common Share - Basic
                
                $
                (0.31
                )
                
                $
                (0.03
                )Net
      Loss Per Common Share - Diluted
                
                $
                (0.31
                )
                
                $
                (0.03
                )Weighted
      Average Number Of Common SharesOutstanding
      - Basic
                
                
                31,172,716
                
                
                
                30,127,255Weighted
      Average Number Of Common SharesOutstanding
      - Diluted
                
                
                31,172,716
                
                
                
                30,127,255
 See
the accompanying report letter and notes to consolidated financial
statements.
 Page
F-5
 QSGI
INC. AND SUBSIDIARIES
 For
The Years Ended December 31, 2007 And 2006
 
 Additional
                
                
                Retained
                
                
                TotalCommonStock
                
                
                Paid-In
                
                
                Earnings
                
                
                Stockholders'Shares
                
                
                Amount
                
                
                Capital
                
                
                (Deficit)
                
                
                EquityBalance
      (Deficit) -January
      1, 2006
                
                
                28,670,631
                
                
                $
                286,706
                
                
                $
                11,093,881
                
                
                $
                (1,996,978
                )
                
                $
                9,383,609Exercise
      Of Stock Options
                
                
                350,000
                
                
                
                3,500
                
                
                
                5,600
                
                
                
                —
                
                
                
                9,100Shares
      Issued For Services
                
                
                88,540
                
                
                
                885
                
                
                
                160,802
                
                
                
                —
                
                
                
                161,687Common
      Shares Issued ForQualTech
      Earn-Out
                
                
                2,063,545
                
                
                
                20,636
                
                
                
                3,385,954
                
                
                
                —
                
                
                
                3,406,590Stock
      Option Compensation
                
                
                —
                
                
                
                —
                
                
                
                18,184
                
                
                
                —
                
                
                
                18,184Preferred
      Stock Dividend
                
                
                —
                
                
                
                —
                
                
                
                (256,389
                )
                
                
                —
                
                
                
                (256,389
                )Accretion
      To The RedemptionValue
      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
                )
                
                
                12,220,488FIN
      48 Adoption
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                (38,000
                )
                
                
                (38,000
                )Stock
      Option Compensation
                
                
                —
                
                
                
                —
                
                
                
                19,430
                
                
                
                —
                
                
                
                19,430Preferred
      Stock Dividend
                
                
                —
                
                
                
                —
                
                
                
                (258,000
                )
                
                
                —
                
                
                
                (258,000
                )Accretion
      To The RedemptionValue
      Of Preferred Stock
                
                
                —
                
                
                
                —
                
                
                
                (18,108
                )
                
                
                —
                
                
                
                (18,108
                )Net
      Loss
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                (9,275,852
                )
                
                
                (9,275,852
                )Balance
      (Deficit) -December
      31, 2007
                
                
                31,172,716
                
                
                $
                311,727
                
                
                $
                14,134,298
                
                
                $
                (11,796,067
                )
                
                $
                2,649,958
 
 See
the accompanying report letter and notes to consolidated financial
statements.
 Page
F-6
  QSGI
INC. AND SUBSIDIARIES
 
 For
      The YearsEnded
      December 31,2007
                
                
                2006Cash Flows From Operating ActivitiesNet
      loss
                
                $
                (9,275,852
                )
                
                $
                (485,237
                )Adjustments
      to reconcile net loss to net cash provided by(used in) operating activitiesGoodwill
      and asset impairment
                
                
                7,206,698
                
                
                
                —Depreciation
      and amortization
                
                
                702,130
                
                
                
                685,216Stock
      option compensation expense
                
                
                19,430
                
                
                
                18,184Deferred
      income taxes
                
                
                174,336
                
                
                
                (271,686
                )Allowance
      for doubtful accounts
                
                
                713,500
                
                
                
                822,965Common
      stock issued for services
                
                
                —
                
                
                
                161,687Changes
      in assets and liabilities:Accounts
      receivable
                
                
                2,977,775
                
                
                
                (1,821,257
                )Inventories
                
                
                (1,595,321
                )
                
                
                (846,406
                )Prepaid
      expenses and other current assets
                
                
                23,389
                
                
                
                18,034Other
      assets
                
                
                (50,417
                )
                
                
                (3,770
                )Accounts
      payable, accrued expenses and other liabilities
                
                
                (660,840
                )
                
                
                139,040Net
      Cash Provided By (Used In) Operating Activities
                
                
                234,828
                
                
                
                (1,583,230
                )Cash
      Flows From Investing ActivitiesAdvances
      for notes receivable
                
                
                (96,250
                )
                
                
                —Collections
      of notes receivable
                
                
                53,200
                
                
                
                —Purchases
      of property and equipment
                
                
                (211,713
                )
                
                
                (153,728
                )Proceeds
      from sale of equipment
                
                
                62,301
                
                
                
                8,274Net
      Cash Used In Investing Activities
                
                
                (192,462
                )
                
                
                (145,454
                )Cash
      Flows From Financing ActivitiesProceeds
      from the issuance of redeemable preferred stock
                
                
                —
                
                
                
                2,236,301Payments
      for financing costs
                
                
                (127,827
                )
                
                
                (40,000
                )Stock
      options exercised
                
                
                —
                
                
                
                9,100Preferred
      stock dividends
                
                
                (258,000
                )
                
                
                (256,389
                )Net
      amounts borrowed (repaid) under revolving line of credit
                
                
                (161,764
                )
                
                
                284,325Stock
      issuance costs
                
                
                —
                
                
                
                (25,499
                )Net
      Cash Provided By (Used In) Financing Activities
                
                
                (547,591
                )
                
                
                2,207,838Net
      Increase (Decrease) In Cash And Cash Equivalents
                
                
                (505,225
                )
                
                
                479,154Cash
      And Cash Equivalents - Beginning Of Year
                
                
                632,948
                
                
                
                153,794Cash
      And Cash Equivalents - End Of Year
                
                $
                127,723
                
                
                $
                632,948Supplemental
      Disclosure Of Cash Flow InformationIncome
      taxes paid
                
                $
                62,591
                
                
                $
                25,428Interest
      paid
                
                
                406,306
                
                
                
                243,196Supplemental
      cash flow information (Note 15)
  See
the accompanying report letter and notes to consolidated financial
statements.
 Page
F-7
 QSGI
INC. AND SUBSIDIARIES
 December
31, 2007 And 2006
 
 1.           SummaryOf 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 for IT products. The Company is geared towards 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, andre-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.  QualTech
Services Group, Inc. provides hardware maintenance solutions and information
systems consulting services to businesses in the United States.
   See
the accompanying report letter.
 Page
F-8
 QSGI
INC. AND SUBSIDIARIES
 
 Notes To
Consolidated Financial Statements
  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,
Florida, Illinois, Indiana, Kansas, Maine, Michigan, New Hampshire, New York,
North Carolina, Nebraska, Ohio, Oklahoma, Pennsylvania, South Carolina, Texas,
and Wyoming.
 
 Management’s
Plans, Liquidity And Going Concern Considerations
  The
Company has incurred net losses in each of the last three years, and is
currently in default of its line of credit agreement (Note 6).  The
lender has the right to immediately call the loan due and payable in
full.  These conditions raise substantial doubt about the Company’s
ability to continue as a going concern.
 
 Management
believes that the Company and the Bank continue to work together in a
cooperative and constructive manner.  At the same time, the Company is
exploring alternative financing.  However, there can be no guarantee
that the Company will be able to obtain alternative financing, or if obtained,
will be on terms favorable to the Company.
 
 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.
   See
the accompanying report letter.
 Page
F-9
  QSGI
INC. AND SUBSIDIARIES
 
 Notes To
Consolidated Financial Statements
 
 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, 2007 and 2006, a warranty reserve was not
considered necessary.
 
 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.
    See
the accompanying report letter.
 Page
F-10
 QSGI
INC. AND SUBSIDIARIES
 
 Notes To
Consolidated Financial Statements
 
 The
allowance for doubtful accounts at December 31, 2007 and 2006, and changes in
the allowance for the years then ended are as follows:
 
 Balance
      At
              Provision
              Write-Offs,
              BalanceBeginning
              For
      Doubtful
              Net
      Of
              At
      EndYear
              Of
      Year
              Accounts
              Recoveries
              Of
      Year2006
              $   80,000
              $
      822,965
              $
      122,849
              $
      780,1162007
              780,116
              713,500
              538,017
              955,599
 
 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.
    See
the accompanying report letter.
 Page
F-11
 QSGI
INC. AND SUBSIDIARIES
 
 Notes To
Consolidated Financial Statements
 
 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 deposits for the Company’s Data Security and
Compliance segment.  These deposits are refundable at the expiration
of the lease.  Since the lease terms extend beyond 12 months, the
deposits are classified as a long-term asset in other assets on the consolidated
balance sheet.
 
 Advertising
Costs
  Advertising
costs are expensed on the first date the advertisement takes
place.  Advertising expense amounted to $89,477 in 2007 and $50,486 in
2006.
 
 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.
   See
the accompanying report letter.
 Page
F-12
 QSGI
INC. AND SUBSIDIARIES
 
 Notes To
Consolidated Financial Statements
  
 The
following table presents the computation of basic and diluted net loss per
share:
 2007
              
              
              2006Net
      loss available to common stockholders
              
              $
              (9,551,960
              )
              
              $
              (758,682
              )Determination
      of basic and diluted shares:Basic
      weighted average shares outstanding
              
              
              31,172,716
              
              
              
              30,127,255Diluted
      weighted average shares outstanding
              
              
              31,172,716
              
              
              
              30,127,255Net
      Loss Per Common Share - Basic
              
              $
              (0.31
              )
              
              $
              (0.03
              )Net
      Loss Per Common Share - Diluted
              
              $
              (0.31
              )
              
              $
              (0.03
              )
 
 In 2007,
the Company excluded 1,370,879 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.
 
 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.
 
 Fair
Value Of Financial Instruments
  The
carrying amounts of financial instruments including cash and cash equivalents,
accounts receivable, notes 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.
   See
the accompanying report letter.
 Page
F-13
 QSGI
INC. AND SUBSIDIARIES
 
 Notes To
Consolidated Financial Statements
   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.
 
 The
weighted average per share fair value of the options granted was $1.41 and $1.43
for the years ended December 31, 2007 and 2006, 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:
 
 2007
              
              
              2006Risk-free
      interest rates
              
              
              4.15
              %
              
              
              4.59
              %Expected
      option lives
              
              1.6
      Years
              
              
              5.0
      yearsExpected
      volatilities
              
              
              70
              %
              
              
              75
              %Expected
      dividend yields
              
              
              0
              %
              
              
              0
              %
 
 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.
   See
the accompanying report letter.
 Page
F-14
  QSGI
INC. AND SUBSIDIARIES
 
 Notes To
Consolidated Financial Statements
   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.
 
 On
January 1, 2007, the Company adopted FASB Interpretation (FIN) No. 48, Accounting for Uncertainty in Income
Taxes - an interpretation of FASB Statement No. 109 (“FIN
48”).  This Interpretation clarifies accounting for uncertainty in
income taxes recognized in an enterprise’s financial statements.  FIN
48 prescribes a recognition threshold and measurement process for a tax position
or expected position to be taken in a tax return.
 
 As a
result of the implementation of FIN 48, the Company recognized an increase of
$38,000 in the liability for income taxes and accrued interest, of which $3,000
related to accrued interest.  This was accounted for as a reduction to
the January 1, 2007 balance of retained earnings
(deficit).  Including the cumulative effect increase on January 1,
2007, the Company had $368,000 of unrecognized tax benefits of which $35,000
would affect the effective tax rate if recognized.  Following
implementation, the ongoing recognition of changes in measurement of uncertain
tax positions as well as interest and penalties related to unrecognized tax
benefits will be reflected as a component of income tax expense.
 
 
 2.  Inventories
 
 Inventories
consist of:
 
 2007
              
              
              2006Finished
      goods
              
              $
              6,120,473
              
              
              $
              4,810,843Inventory
      in transit
              
              
              708,558
              
              
              
              246,867Allowance
      for excess and obsolescence
              
              
              (251,000
              )
              
              
              (75,000
              )$
              6,578,031
              
              
              $
              4,982,710
  
 See
the accompanying report letter.
 Page
F-15
 QSGI
INC. AND SUBSIDIARIES
 
 Notes To
Consolidated Financial Statements
  
 3.  Property
And Equipment
 
 Property
and equipment consist of:
 
 2007
              
              
              2006Furniture
      and fixtures
              
              $
              114,798
              
              
              $
              152,384Equipment
              
              
              454,921
              
              
              
              458,537Leasehold
      improvements
              
              
              130,754
              
              
              
              92,862Computer
      equipment and software
              
              
              599,503
              
              
              
              610,0041,299,976
              
              
              
              1,313,787Less:  Accumulated
      depreciation
              
              
              1,013,210
              
              
              
              903,546$
              286,766
              
              
              $
              410,241
 
 
 Depreciation
and amortization charged against income for all property and equipment amounted
to $278,887 and $341,100 for the years ended December 31, 2007 and 2006,
respectively.
 
 
 4.           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.
 
 Goodwill
increased during 2006 due to the additional merger consideration payment of
$3,432,089.
 
 Intangibles
increased during 2007 as the result of an asset purchase completed July 1,
2007.  The intangibles acquired consisted of a website, database, EBay
storefront and employee non-competes.  Amortization of those
intangibles is computed on a straight-line basis over a three-year life starting
July 1, 2007.  The increase in intangibles assets occurred in the Data
Security and Compliance segment.  The acquisition was funded by the
reduction of the seller’s accounts receivable balance due to the
Company.
   See
the accompanying report letter.
 Page
F-16
 QSGI
INC. AND SUBSIDIARIES
 
 Notes To
Consolidated Financial Statements
   During
the fourth quarter of 2007, the Company performed an impairment test on goodwill
and intangibles and has determined that their carrying value was impaired and
recorded an impairment charge of $5,154,782 for goodwill and $2,051,916 for
intangibles associated with the Data Center Hardware reporting
unit.  During the fourth quarter of 2006, the Company performed an
impairment test and determined that the carrying value of such assets were not
impaired as of that date.
 
 The
impairment of goodwill and intangibles was due to what the Company believes to
be actionable, anticompetitive business practices by a leading
OEM.  This OEM significantly diminished the Company’s ability to
resell IBM zSeries mainframe systems by setting onerous restrictions around the
ability to upgrade or downgrade the configuration deployed on the
system.  As a result, the Company’s hardware trading business was
significantly reduced, which resulted in a total write-off of goodwill and
intangibles in the Data Center Hardware segment.
 
 To
determine fair values for the purposes of calculating impairment in the Data
Center Hardware segment, the Company used both a market and an income approach
to derive fair value.  The market approach compares the value of the
assets to similar business interests of other companies of similar
size.  The income approach applies a discounted cash flow analysis to
the Company’s future sales and income projections.
 
 At
December 31, 2007 and 2006, the balance of goodwill and intangible assets is as
follows:
 2007
              
              
              2006Goodwill
              
              $
              1,489,621
              
              
              $
              6,644,403Intangible
      assets with indefinite lives
              
              
              70,000
              
              
              
              910,000Intangible
      assets with finite lives, net
              
              
              400,348
              
              
              
              1,645,584$
              1,959,969
              
              
              $
              9,199,987
   See
the accompanying report letter.
 Page
F-17
 QSGI
INC. AND SUBSIDIARIES
 
 Notes To
Consolidated Financial Statements
  At
December 31, 2007 and 2006, the balance of goodwill is as follows:
 
 DataData
              
              
              Data
              
              
              SecurityCenter
              
              
              Center
              
              
              AndHardware
              
              
              Maintenance
              
              
              Compliance
              
              
              TotalBalance
      December 31, 2006
              
              $
              5,154,782
              
              
              $
              1,489,621
              
              
              $
              —
              
              
              $
              6,644,403Less:  Goodwill
      impairment
              
              
              5,154,782
              
              
              
              —
              
              
              
              —
              
              
              
              5,154,782Balance
      December 31, 2007
              
              $
              —
              
              
              $
              1,489,621
              
              
              $
              —
              
              
              $
              1,489,621
 
 Intangibles
with indefinite lives relate principally to trade names.  At
December 31, 2007 and 2006, the balance of intangibles with indefinite
lives is as follows:
 DataData
              
              
              Data
              
              
              SecurityCenter
              
              
              Center
              
              
              AndHardware
              
              
              Maintenance
              
              
              Compliance
              
              
              TotalBalance
      December 31, 2006
              
              $
              840,000
              
              
              $
              70,000
              
              
              $
              —
              
              
              $
              910,000Less:  Impairment
              
              
              840,000
              
              
              
              —
              
              
              
              —
              
              
              
              840,000Balance
      December 31, 2007
              
              $
              —
              
              
              $
              70,000
              
              
              $
              —
              
              
              $
              70,000
 
 Intangibles
with finite lives relate principally to the following:
 
 20072006
              
              
              2007
              
              
              2007
              
              
              AdjustedCost
              
              
              Impairment
              
              
              Additions
              
              
              CostCustomer
      lists
              
              $
              1,640,000
              
              
              $
              (1,520,000
              )
              
              $
              —
              
              
              $
              120,000Database
              
              
              400,000
              
              
              
              (400,000
              )
              
              
              25,000
              
              
              
              25,000Employee
              
              
              450,000
              
              
              
              (278,000
              )
              
              
              25,000
              
              
              
              197,000noncompetesWebsite
              
              
              —
              
              
              
              —
              
              
              
              50,000
              
              
              
              50,000EBay
      Storefront
              
              
              —
              
              
              
              —
              
              
              
              240,000
              
              
              
              240,000Total
              
              $
              2,490,000
              
              
              $
              (2,198,000
              )
              
              $
              340,000
              
              
              $
              632,000
   See
the accompanying report letter.
 Page
F-18
 QSGI
INC. AND SUBSIDIARIES
 
 Notes To
Consolidated Financial Statements
 
 2006
              
              
              
              
              
              
              
              
              2007
              
              
              2007
              
              
              RemainingAccumulated
              
              
              2007
              
              
              2007
              
              
              Accumulated
              
              
              Net
              
              
              AmortizationAmortization
              
              
              Amortization
              
              
              Impairment
              
              
              Amortization
              
              
              Intangibles
              
              
              Life
      (Years)Customer
      lists
              
              $
              485,888
              
              
              $
              182,208
              
              
              $
              (619,256
              )
              
              $
              48,840
              
              
              $
              71,160
              
              
              
              5.3Database
              
              
              118,528
              
              
              
              48,612
              
              
              
              (162,976
              )
              
              
              4,164
              
              
              
              20,836
              
              
              2.5
      to 5.3Employeenoncompetes
              
              
              240,000
              
              
              
              94,164
              
              
              
              (203,852
              )
              
              
              130,312
              
              
              
              66,688
              
              
              1.3
      to 2.5Website
              
              
              —
              
              
              
              8,334
              
              
              
              —
              
              
              
              8,334
              
              
              
              41,666
              
              
              
              2.5EBay
      Storefront
              
              
              —
              
              
              
              40,002
              
              
              
              —
              
              
              
              40,002
              
              
              
              199,998
              
              
              
              2.5Total
              
              $
              844,416
              
              
              $
              373,320
              
              
              $
              (986,084
              )
              
              $
              231,652
              
              
              $
              400,348
 
 2006
              
              
              2006
              
              
              Remaining2006
              
              
              2006
              
              
              Accumulated
              
              
              Net
              
              
              AmortizationCost
              
              
              Amortization
              
              
              Amortization
              
              
              Intangibles
              
              
              Life
      (Years)Customer
      lists
              
              $
              1,640,000
              
              
              $
              182,208
              
              
              $
              485,888
              
              
              $
              1,154,112
              
              
              
              6.4Database
              
              
              400,000
              
              
              
              44,448
              
              
              
              118,528
              
              
              
              281,472
              
              
              
              6.4Employeenoncompetes
              
              
              450,000
              
              
              
              90,000
              
              
              
              240,000
              
              
              
              210,000
              
              
              
              2.4Total
              
              $
              2,490,000
              
              
              $
              316,656
              
              
              $
              844,416
              
              
              $
              1,645,584
 
 Amortization
of intangibles is computed on a straight-line basis and based on December 31,
2007 balances, expected amortization expense in each of the next five years and
thereafter is as follows:
 
 Year
              
              Amount2008
              
              $
              161,0522009
              
              
              138,0962010
              
              
              70,0002011
              
              
              13,3202012
              
              
              13,320Thereafter
              
              
              4,560$
              400,348
 
  See
the accompanying report letter.
 Page
F-19
 QSGI
INC. AND SUBSIDIARIES
 
 Notes To
Consolidated Financial Statements
 
 5.           Other
Assets
 
 Other
assets consist of:
 
 2007
              
              
              2006Deposits
              
              $
              83,306
              
              
              $
              78,422Trademark
              
              
              7,885
              
              
              
              7,885Patent,
      net of amortization of $4,541in
      2007 and $3,330 in 2006
              
              
              19,675
              
              
              
              20,886Deferred
      loan costs
              
              
              116,435
              
              
              
              40,000Notes
      receivable
              
              
              150,725
              
              
              
              —Other
              
              
              70,040
              
              
              
              11,591$
              448,066
              
              
              $
              158,784
 
 The
patent is being amortized over a 20-year life.  Patent amortization
expense in 2007 and 2006 amounted to $1,211.  Expected amortization
expense in each of the next five years is $1,211 per year.
 
 Notes
receivable consist of secured amounts due from one current and one former
employee, bearing interest at rates from 0% to 12.5%, payable in varying amounts
through 2011.
 
 
 6.           Financing
Arrangements
 
 Revolving
Line Of Credit
  On
January 17, 2007, the Company completed the financing of a new $7,500,000
working capital facility with Wells Fargo Bank, which increased and replaced a
similar based line of credit of $4,250,000.  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 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.
   See
the accompanying report letter.
 Page
F-20
 QSGI
INC. AND SUBSIDIARIES
 
 Notes To
Consolidated Financial Statements
 
 On June
29, 2007, the Company completed an amendment to the revolving line of credit
which reset some of the covenants.  The amended revolving
line-of-credit minimum net income requirements are as follows:
 
 Year
      To DatePeriod
      Ending
              Net
      IncomeMarch
      31, 2008
              $
      100,000June
      30, 2008
              300,000September
      30, 2008
              500,000December
      31, 2008
              800,000March
      31, 2009
              100,000June
      30, 2009
              300,000September
      30, 2009
              500,000December
      31, 2009
              800,000
 
 Availability
on the borrowing base at December 31, 2007 was $287,684.  Interest on
this loan is payable monthly at the prime rate plus 1.5% (8.75% at
December 31, 2007), with all principal and interest due January 24,
2010.  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.
 
 The
Company was in not in compliance with all of its covenants at December 31,
2007.  The bank has notified the Company that it is out of compliance
with its covenants and is in default on the loan.  The bank has the
right to immediately call the loan due and payable in full.  In
February 2008, the bank began charging interest at a default rate equal to the
prime rate plus 2.5%, and charged a fee of $20,000.
 
 
 7.           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 20 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.
   See
the accompanying report letter.
 Page
F-21
 QSGI
INC. AND SUBSIDIARIES
 
 Notes To
Consolidated Financial Statements
  
 
 8.           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 (SARs) 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 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.
 
 Stock
option compensation expense in the amount of $19,430 and $18,184 was recorded in
2007 and 2006, respectively.
  See
the accompanying report letter.
 Page
F-22
 QSGI
INC. AND SUBSIDIARIES
 
 Notes To
Consolidated Financial Statements
   A summary
of stock option activity is as follows:
 
 2007
              
              
              2006Weighted
      -
              
              
              
              
              
              Weighted
      -Average
              
              
              
              
              
              AverageExercise
              
              
              
              
              
              ExerciseShares
              
              
              Price
              
              
              Shares
              
              
              PriceOutstanding
      -January
      1
              
              
              12,221,834
              
              
              $
              1.972
              
              
              
              12,566,834
              
              
              $
              1.918Granted
              
              
              40,000
              
              
              
              1.405
              
              
              
              30,000
              
              
              
              1.430Exercised
              
              
              —
              
              
              
              —
              
              
              
              (350,000
              )
              
              
              0.026Forfeited
              
              
              (892,000
              )
              
              
              2.471
              
              
              
              (25,000
              )
              
              
              1.540Outstanding
      on December 31
              
              
              11,369,834
              
              
              $
              1.930
              
              
              
              12,221,834
              
              
              $
              1.972Exercisable
      on December 31
              
              
              11,330,834
              
              
              $
              1.932
              
              
              
              12,165,167
              
              
              $
              1.973
 
 Unrecognized
stock option compensation cost related to unvested stock options amounts to
approximately $34,000.  The cost is expected to be recognized over the
next four years.
 
 The
following table summarizes information about the options outstanding at December
31, 2007:
 
 ExercisableOutstanding
      Stock Options
              
              Stock
      OptionsWeighted
      -Average
              Weighted
      -
              
              
              Weighted
      -Range
      Of
              
              Remaining
              Average
              
              
              AverageExercise
              
              Contractual
              Exercise
              
              
              ExercisePrices
              Shares
              Life
              Price
              
              Shares
              Price$
      0.026
              1,740,000
              4.1
              $
      0.026
              
              1,740,000
              $
      0.0261.01
      to 1.90
              2,433,334
              6.2
              1.671
              
              2,394,334
              1.6742.00
      to 2.13
              2,255,000
              6.9
              2.007
              
              2,255,000
              2.0072.50
      to 2.75
              4,725,000
              7.2
              2.659
              
              4,725,000
              2.6593.45
      to 3.46
              216,500
              3.0
              3.450
              
              216,500
              3.45011,369,834
              
              
              
              11,330,834
    See
the accompanying report letter.
 Page
F-23
 QSGI
INC. AND SUBSIDIARIES
 
 Notes To
Consolidated Financial Statements
  Warrants
  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 October 2007, these warrants expired.
 
 A
schedule of common stock warrant activity is as follows:
 
 Weighted
      -Number
              
              
              AverageOf
              
              
              ExerciseShares
              
              
              PriceOutstanding
      at December 31, 2006 and 2005
              
              
              933,333
              
              
              $
              3.00Warrants
      issued
              
              
              —
              
              
              
              —Warrants
      expired
              
              
              (350,000
              )
              
              
              2.00Outstanding
      at December 31, 2007
              
              
              583,333
              
              
              $
              3.60
 
 The
following table summarizes information about the warrants outstanding at
December 31, 2007:
 
 Outstanding
      Stock Warrants
              
              Exercisable
      WarrantsWeighted-Average
              Weighted-
              
              
              Weighted-Remaining
              Average
              
              
              AverageExercise
              
              Contractual
              Exercise
              
              
              ExercisePrice
              Number
              Life
              Price
              
              Shares
              Price$
      3.60
              583,333
              1.38
              $
      3.60
              
              583,333
              $
      3.60
 
  See
the accompanying report letter.
 Page
F-24
 QSGI
INC. AND SUBSIDIARIES
 
 Notes To
Consolidated Financial Statements
  9.           Income
Taxes
 
 The
expense (benefit) for income taxes consists of the following:
 
 2007
              
              
              2006Current
              
              $
              69,468
              
              
              $
              29,313Deferred
              
              
              174,336
              
              
              
              (271,686
              )$
              243,804
              
              
              $
              (242,373
              )
 
 The tax
effects of temporary differences and carry forwards that give rise to
significant portions of deferred tax assets and liabilities consist of the
following:
 
 2007
              
              
              2006Deferred
      Tax AssetsLiabilities
      and reserves
              
              $
              651,393
              
              
              $
              356,220Net
      operating loss carryforwards
              
              
              1,612,300
              
              
              
              1,499,268Stock
      options
              
              
              19,362
              
              
              
              36,732Inventory
      capitalization
              
              
              240,024
              
              
              
              129,585Property
      and equipment
              
              
              66,559
              
              
              
              31,5262,589,638
              
              
              
              2,053,331Valuation
      allowance
              
              
              (2,527,374
              )
              
              
              (873,183
              )62,264
              
              
              
              1,180,148Deferred
      Tax LiabilitiesPrepaid
      expenses
              
              
              26,449
              
              
              
              28,113Patent
      and trademark
              
              
              7,859
              
              
              
              8,321Intangibles
              
              
              55,256
              
              
              
              996,67889,564
              
              
              
              1,033,112Net
      Deferred Tax Asset (Liability)
              
              $
              (27,300
              )
              
              $
              147,036
 
 The
current and long-term components of the net deferred tax liability are as
follows:
 2007
              
              
              2006Current
      deferred tax asset
              
              $
              —
              
              
              $
              598,661Long-term
      deferred tax liability
              
              
              (27,300
              )
              
              
              (451,625
              )$
              (27,300
              )
              
              $
              147,036
   See
the accompanying report letter.
 Page
F-25
  QSGI
INC. AND SUBSIDIARIES
 
 Notes To
Consolidated Financial Statements
  The
reconciliation of the effective tax rate with the statutory federal income tax
benefit rate is as follows:
 2007
              
              
              2006Statutory
      federal rate
              
              
              34
              %
              
              
              34
              %State
      income taxes, net of federal benefits
              
              
              1
              
              
              
              1Goodwill
      impairment
              
              
              (19
              )
              
              
              —Change
      in valuation allowance
              
              
              (18
              )
              
              
              —Meals,
      entertainment and club dues
              
              
              (1
              )
              
              
              (2
              )(3
              )%
              
              
              33
              %
 
 The
Company’s ability to utilize the cumulative tax net operating loss carryforward
of approximately $4,700,000 at December 31, 2007 against future taxable income
will begin to expire on December 31, 2022 and is subject to Section 382
limitations, as defined by Section 382 of the Internal Revenue Code of 1986, of
approximately $594,000 per year.
 
 The
Company adopted the provisions of FIN 48 as of January 1, 2007.  As a
result of the implementation of FIN 48, the Company recognized a $38,000
increase in the liability for unrecognized tax benefits which was accounted for
as a reduction to the January 1, 2007 balance of retained earnings.  A
reconciliation of the beginning and ending amount of unrecognized tax benefits
is as follows:
 
 Balance
      at January 1, 2007
              
              $
              368,000Additions
      based on tax positions related to the current year
              
              
              2,500Settlements
              
              
              (358,000
              )$
              12,500
 
 During
the second quarter of 2007, the Internal Revenue Service (IRS) completed the
examination of the Company’s consolidated federal income tax return for
2004.  The examination resulted in additional tax due of approximately
$6,400, as well as adjustments to the Company’s balance of net operating loss
carryforwards.  As a result of the completion of the examination, the
Company reduced its unrecognized tax benefits by $358,000.  In 2007,
the Company accrued an additional liability of $2,500 for tax positions related
to the current year.
    See
the accompanying report letter.
 Page
F-26
 QSGI
INC. AND SUBSIDIARIES
 
 Notes To
Consolidated Financial Statements
 The
entire balance of $12,500 of unrecognized tax benefits at December 31, 2007
would impact the effective tax rate if recognized.  The Company
recognizes interest and penalties related to unrecognized tax benefits in
accrued expenses.  The liability for unrecognized tax benefits
included accrued interest of $3,000 and $1,000 at January 1, 2007 and December
31, 2007, respectively.  The Company is currently open to audit under
the statute of limitations by the Internal Revenue Service and various state
income tax authorities from 2005 through 2007.
 
 
 11.           Concentrations
 
 Major
Customers
  For the
years ended December 31, 2007 and 2006, sales to the Company’s top ten customers
comprised approximately 31% and 44% of revenue, respectively.  Sales
to one of these customers comprised approximately 6% and 11% of sales in 2007
and 2006, respectively. The Company’s top ten customers also comprised
approximately 19% and 51% of the accounts receivable balance at December 31,
2007 and 2006, respectively.
 
 Purchases
  The
Company purchases a majority of its products from a small number of
suppliers.  Approximately 61% and 51% of product purchases were from
three vendors for the years ended December 31, 2007 and 2006,
respectively.
 
 
 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 $185,502 and $63,327 to the plan during the years ended
December 31, 2007 and 2006, respectively.
  
 See
the accompanying report letter.
 Page
F-27
 QSGI
INC. AND SUBSIDIARIES
 
 Notes To
Consolidated Financial Statements
 13.           Commitments
And Contingencies
 
 Lease
  The
Company has three operating leases on New Jersey real property. Two are month to
month leases 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 2008.
 
 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
2009.
 
 The
Company has an operating lease on Florida real property expiring in the year
2012.
 
 The
Company has an operating lease on equipment expiring in the year
2008.
 
 Rent
expense and other charges totaled $831,801 and $782,979 for the years ended
December 31, 2007 and 2006, respectively.
 
 The
approximate minimum payments required under these operating leases at December
31, 2007 are:
 
 Year
              
              Amount2008
              
              $
              655,7172009
              
              
              502,2082010
              
              
              299,5092011
              
              
              255,0072012
              
              
              28,350$
              1,740,791
   See
the accompanying report letter.
 Page
F-28
 QSGI
INC. AND SUBSIDIARIES
 
 Notes To
Consolidated Financial Statements
 
 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 consolidated 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, and
were renewed for an additional term of three years in 2007.  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 proceeding 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.
 
 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 affect 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 2007
and 2006, the Company had sales to one customer related to one stockholder and
officer of the Company.  Sales to this customer for the years ended
December 31, 2007 and 2006 amounted to approximately $85,000 and $158,000,
respectively.  Accounts receivable from this customer amounted to
$49,529 at December 31, 2007.  No accounts receivable from this
customer was outstanding at December 31, 2006.
   See
the accompanying report letter.
 Page
F-29
 QSGI
INC. AND SUBSIDIARIES
 
 Notes To
Consolidated Financial Statements
 
 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, 2007 and
2006, rent expense for this lease amounted to $221,788 and $179,585,
respectively.
 
 In
November 2007, the Company exercised an option to purchase a portion of the
assets on lease from Varilease Technology Finance Group for approximately
$35,000.  This purchase reduces the monthly rental by approximately
$10,600 per month.  No accounts payable was outstanding to this vendor
at December 31, 2007 or 2006.
 
 
 15.           Supplemental
Cash Flow Information
 
 During
2007, the Company issued no additional shares of common stock.  During
2006, the Company issued 88,540 shares of its common stock for services rendered
during 2006 with two vendors for $161,687.  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.
 
 On July
1, 2007, the Company completed a small asset purchase.  The majority
of the purchase price was assigned to intangibles in the Data Security and
Compliance segment.  The amortization of these intangible assets is
computed on a straight-line basis over a three-year life starting in July
2007.  The acquisition price was funded by the reduction of the
seller’s accounts receivable balance due to the Company.
 
 
 16.           Segment
Information
 
 The
Company operates 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.
   See
the accompanying report letter.
 Page
F-30
 QSGI
INC. AND SUBSIDIARIES
 
 Notes To
Consolidated Financial Statements
 
 Data
Security And Compliance Segment
  This
segment provides data security and regulatory compliance services for
end-of-life business-computing 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.
 
 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 are generally accounted for as sales
to third parties at cost and eliminated in consolidation.  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 in 2007 and 2006.  Management fees charges to the
Data Center Maintenance segment amounted to $720,000 and $660,000 in 2007 and
2006, respectively.  These intersegment transactions have been
eliminated in consolidation.
   See
the accompanying report letter.
 Page
F-31
 QSGI
INC. AND SUBSIDIARIES
 
 Notes To
Consolidated Financial Statements
 
 2007
              
              
              2006RevenuesProducts
              
              $
              30,126,257
              
              
              $
              41,111,420Services
              
              
              7,094,853
              
              
              
              5,297,497$
              37,221,110
              
              
              $
              46,408,917RevenuesData Security And
      Compliance
              
              $
              20,741,618
              
              
              $
              22,013,739Data Center
      Hardware
              
              
              11,100,092
              
              
              
              20,035,133Data Center
      Maintenance
              
              
              6,264,981
              
              
              
              4,847,885Intersegment
      Elimination
              
              
              (885,581
              )
              
              
              (487,840
              )Consolidated
      Total
              
              $
              37,221,110
              
              
              $
              46,408,917
 
 Income
      (Loss) Before Benefit ForIncome TaxesData Security And
      Compliance
              
              $
              (3,046,216
              )
              
              $
              (2,763,369
              )Data Center
      Hardware
              
              
              (7,208,456
              )
              
              
              775,849Data Center
      Maintenance
              
              
              1,222,624
              
              
              
              1,259,910Consolidated
      Total
              
              $
              (9,032,048
              )
              
              $
              (727,610
              )
 
 Depreciation
      And AmortizationData Security And
      Compliance
              
              $
              299,655
              
              
              $
              225,516Data Center
    Hardware
              
              
              343,347
              
              
              
              397,358Data Center
      Maintenance
              
              
              59,308
              
              
              
              62,342Consolidated
      Total
              
              $
              702,310
              
              
              $
              685,216
 
 Segment
      AssetsData Security And
      Compliance
              
              $
              8,592,896
              
              
              $
              8,879,411Data Center
    Hardware
              
              
              1,264,945
              
              
              
              12,669,721Data Center
      Maintenance
              
              
              3,559,629
              
              
              
              2,629,689Consolidated
      Total
              
              $
              13,417,470
              
              
              $
              24,178,821
   See
the accompanying report letter.
 Page
F-32
 QSGI
INC. AND SUBSIDIARIES
 
 Notes To
Consolidated Financial Statements
   
 2007
              
              
              2006GoodwillData Security And
      Compliance
              
              $
              —
              
              
              $
              —Data Center
    Hardware
              
              
              —
              
              
              
              5,154,782Data Center
      Maintenance
              
              
              1,489,621
              
              
              
              1,489,621Consolidated
    Total
              
              $
              1,489,621
              
              
              $
              6,644,403
 
 Expenditures
      For Property AndEquipmentData Security And
      Compliance
              
              $
              190,082
              
              
              $
              127,087Data Center
    Hardware
              
              
              21,631
              
              
              
              16,564Data Center
      Maintenance
              
              
              —
              
              
              
              10,077Consolidated
    Total
              
              $
              211,713
              
              
              $
              153,728
 
 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 had a small call center in India, which
closed in 2007.  Foreign currency transaction gains or losses were not
material in 2007 or 2006.
 
 For the
years ended December 31, 2007 and 2006, export sales comprised 17% and 14%,
respectively, of revenue.
 
 Revenue
by Geographic Segment comprised:
 
 2007
              
              
              2006United
      States
              
              $
              31,028,368
              
              
              $
              40,024,087Asia
              
              
              1,394,935
              
              
              
              1,824,038Middle
      East
              
              
              2,404,862
              
              
              
              1,823,709Europe
              
              
              478,557
              
              
              
              219,608Africa
              
              
              593,044
              
              
              
              602,447United
      Kingdom
              
              
              485,478
              
              
              
              935,473Canada
              
              
              556,392
              
              
              
              324,056Australia
              
              
              —
              
              
              
              12,825South
      America
              
              
              279,474
              
              
              
              642,674Consolidated
    Total
              
              $
              37,221,110
              
              
              $
              46,408,917





Page F-33